Q&A: Getting out of a bad car loan can be tricky

Dear Liz: My car payment is $465 a month with a 22% interest rate. I need to get out of this car and into a lower car payment. My credit is poor. What is the best solution to go about this?

Answer: There are a number of solutions, most of which probably won’t work for you.

If you could do without a car for a while and owe less than this car is worth, you could sell it to pay off the loan. The fact you haven’t already done so indicates that you either need a car or have no equity, or both.

Fixing your credit could help you get a better deal, but that’s tough to do with an unaffordable car payment. You need to have enough free cash flow to put a down payment on a secured credit card or make monthly payments on a credit builder loan, which are two of the best ways to rehabilitate your credit. Your finances also have to be sound enough that you don’t miss payments on any credit obligation, including the car.

If you bought an overpriced jalopy from a “buy here, pay here lot,” or you were approved at a regular dealership but your rate got jacked up at the last minute, the dealer may have violated Truth in Lending laws that would allow you to get out of the deal. You’d probably need an attorney to help you pursue this option. You may luck out and find one that can help you at your local legal aid society. Otherwise, you could check with the National Assn. of Consumer Advocates to see if you can find affordable help.

Even if you were successful in getting out of this loan, of course, you still are likely to need a car and you’d still have bad credit, which means that you probably wouldn’t get a better deal on the next car than the bad one you have now.

If you can, the best option might be to get a second job or ask for overtime hours to pay this loan off as fast as possible. Then you could get a credit builder loan, which puts the money you borrow into a certificate of deposit you can claim after making 12 monthly payments. This small loan could be enough to significantly boost your credit scores and give you some cash to make a down payment on the next vehicle.

Q&A: Paying credit card debt after death

Dear Liz: I am 80 and I have a substantial amount of credit card debt, approximately $30,000. What becomes of this credit card debt in the event of my death? Will it become a future liability for my two sons or will this eventually become a bad debt for the credit card company? I would hate to see this become a financial burden for my sons.

Answer: Any credit card balances you leave behind will be a liability for your estate, not for your sons — although the debt could reduce any inheritance they get. Creditors have to be paid before any remaining assets are distributed. If you don’t have enough assets to cover the bill, creditors will get a proportionate amount of whatever’s left after paying your final expenses. Any remaining debt will be a write-off for the creditor, and your sons typically wouldn’t get anything.

You didn’t ask for help dealing with this debt, but you shouldn’t assume you can just tread water until you die and leave it for someone else to sort out. Your life expectancy at age 80 is another eight years if you’re male and nearly 10 years if you’re female, and you could live considerably longer. If overspending or medical bills led to the debt, you could accrue a lot more before you’re done. If you rack up so much debt that you can’t make the minimum payments, your interest rates could skyrocket and you may have to fend off collection calls.

You should at least discuss your options with an experienced bankruptcy attorney and with a nonprofit credit counselor.

Q&A: What to consider before paying off a vehicle loan

Dear Liz: In January, I used financing to buy a used car, and now I have about $8,000 left to pay off. I recently received a windfall and can pay off that debt in full. Is there any reason to not go ahead and do that? This car loan is my only current debt. However, I do anticipate buying a home and thus getting a mortgage in the near future. Additionally, would paying off the car loan help lower my auto insurance payment?

Answer: Having an open installment loan showing on your credit reports can help your scores, according to credit expert Barry Paperno, who used to work for leading credit scoring firm FICO. But paying it off shouldn’t hurt you much if at all. By contrast, paying off revolving debts such as credit card balances can give a real boost to your scores.

Paying off the loan should save you some interest and eliminating the payment could help you qualify for a bigger mortgage. Those are real advantages. Still, there may be better uses for your windfall. Are you taking full advantage of your 401(k) match, if your company offers one? If you don’t have a workplace retirement plan, are you contributing to an IRA? Do you have an emergency fund?

A paid-off car doesn’t automatically qualify for lower insurance rates. You can consider dropping collision and comprehensive coverage on older cars, since you’re no longer required to carry that coverage, but make sure that you’re comfortable with the risk of not getting anything from your own insurer to repair or replace your car if, for example, you cause an accident and your car is damaged.

Q&A: Divorced, and in debt

Dear Liz: I recently got divorced and found myself in about $50,000 of credit card debt. While I’m struggling to slowly pay off this debt, I do have some money saved in a tax-sheltered annuity as well as a small Roth IRA. Should I use those, take a personal loan or file for bankruptcy?

Answer: A good rule of thumb is to leave retirement money alone for retirement. Early withdrawals can trigger taxes and penalties that eat up one quarter to one half of what you take out. You can always withdraw your contributions tax free from a Roth, but any earnings can trigger taxes and penalties. The biggest cost, though, is the loss of future tax-deferred compounding that can equal 10 times or more of what you take out.

If your credit is good, low-rate balance transfer offers could help you lower the interest rate on your debt so you can pay it off faster. A personal loan from a credit union, your bank or an online lender could work if it offers a low, fixed rate and a repayment term of five years or less.

If you can’t pay this debt off within five years, then you should talk to both a credit counselor (visit the National Foundation for Credit Counseling at www.nfcc.org) and a bankruptcy attorney (referrals from the National Assn. of Consumer Bankruptcy Attorneys at www.nacba.org).

Q&A: Are credit checks a scam?

Dear Liz: In July last year, I accessed the website for my free credit report before applying for a car loan. I have also been in recovery from cancer treatment and haven’t been great about checking my Visa statement until now. For the past year, my credit card has been charged $19.95 each month for some kind of “credit check” service. I never authorized this, nor did I request this service. I contacted the site, and they will refund me only one month of billing. Is this some kind of scam? How do they get away with this, and what can I do?

Answer: It may not technically be a scam, but the site’s business model profits from people’s confusion about how to get free credit reports.

The site you used is not the federally mandated site for free credit reports. It’s likely one that you found by typing “free credit reports” into a search engine and then clicking on one of the first results, which was probably an ad. To find the real site, you need to type www.annualcreditreport.com into your browser. You won’t need to give your credit card number to get your reports.

You may be able to get another month’s fee refunded by contacting your credit-card issuer and disputing the charge. By federal law, you’re supposed to make such disputes within 60 days after the statement containing the disputed charge was sent to you. Write to the issuer at its address for billing inquiries (not the address where you send your payments) and send it certified mail, return receipt requested.

Q&A: The ins and outs of credit scores

Dear Liz: I’ve been using a free credit site to learn more about credit reports and credit scores. Recently I looked around and found reviews about how “horribly inaccurate” these free scores are. Where can I go to find my real FICO credit scores? I need the ones that matter, the ones that lenders use.

Answer: Some free scores aren’t used by any lenders. But many sites these days give out VantageScores, a FICO rival that’s being used in a growing number of credit decisions. So VantageScores are “real” scores, just not the most commonly used scores.

Here’s the thing, though: You generally can’t predict which scores a lender will use. Not only are there different name brands, but FICO offers versions customized for certain types of lending. The scores typically used by credit card issuers are different from the ones used by auto lenders, for example. These industry-specific FICO scores are on a 250-to-900 scale, rather than the 300-to-850 scale used by other FICO scores.

There are also different generations of each type of score, much like the different operating systems for your computer. Some lenders quickly upgrade to the latest version, just as some computer users upgraded to Windows 10 when it came out. Others use older versions of the scores, just as users may cling to Vista or XP. (For you Mac users, that would be something like hanging on to Mountain Lion or Snow Leopard instead of updating to El Capitan.)

Mortgage lenders, in particular, use relatively old versions of FICO. That’s because the agencies that buy most home loans, Fannie Mae and Freddie Mac, haven’t updated their requirements so that lenders can use newer versions.

Some credit card companies offer their customers free FICO scores, typically from one bureau. You can get a glimpse of the array of scores lenders might use by buying the most commonly used FICO, the FICO 8, for about $20 each from MyFico.com. Along with each FICO 8 you buy (you can buy three, one from each of the three major credit bureaus), you’ll get additional versions used for auto, credit card and mortgage lending.

If you’re going to be in the market for a major loan, such as a car loan or a mortgage, it makes sense to buy your FICOs so you can get a better idea of how lenders might view you. If you’re just interested in tracking your scores generally, though, the free versions can be perfectly adequate.

Q&A: Defaults on a co-signed student loan

Dear readers: A recent column about private student loans prompted financial aid expert Mark Kantrowitz to reach out with some additional advice for people who co-signed student loans for someone who has stopped paying. Although private student loans don’t have the same rehabilitation options as federal student loans, Kantrowitz encourages anyone in this situation to ask the lender, “What are my options?” and “Can you remove the default?”

“I’ve seen lenders not only remove the default from the co-signer’s credit history, but even reduce the interest rate if the co-signer agrees to make the payments by auto-debit,” said Kantrowitz, coauthor of the book “File the FAFSA.”

Someone who agrees to make payments may get a better deal than someone who pays off the loan in a lump sum, Kantrowitz said, because lenders want to be paid interest. But there would be nothing to stop a co-signer who makes payment arrangements to pay off the debt in full after a few months.

“This way he potentially can have the default entirely removed from his credit history, restoring him to his previous credit score,” Kantrowitz said. “It also leaves the account open, so that he can pressure the [borrower] into making payments.”

Q&A: Co-signing for a student loan backfires

Dear Liz: My wife and I both had excellent credit scores. Now mine are in the dump. I co-signed for a friend’s daughter’s school loan 10 years ago. I know now this was a bad mistake. I guaranteed $25,000. Now two things have happened: The daughter quit paying the loan and the friendship took a bad turn.

This is seriously hurting my credit. We have already been told when trying to refinance our mortgage that we’ll need to fix the school loan, which is showing more than 90 days behind. The outstanding balance is $20,000. I can pay the loan off. Making payments just adds interest to the problem. Are there any other options to repair my credit that don’t rely on the daughter’s ability to keep the loan current?

Answer: If you can pay the loan off, then do. You are legally responsible for this debt, and the longer it goes unpaid the worse the damage to your credit scores.

If this were a federal student loan, you would have the option of rehabilitation, which can erase some of the negative marks on your credit reports after you make a series of on-time payments. Because it’s a private loan — I know this because federal student loans don’t have co-signers — you probably don’t have a rehabilitation option (although it certainly doesn’t hurt to ask).

Once the loan is paid off, you can proceed with the refinancing but you probably will find that lenders want to base the loan on your battered scores, rather than your wife’s better ones. That means you might not qualify, or you might have to pay a much higher rate. If she can qualify for the refinance on her own, that’s one option. Otherwise, you might have to wait for your credit to heal before you refinance.

Q&A: Fixing a wounded credit score

Dear Liz: My wife and I co-signed on our daughter’s mortgage, then the home went into foreclosure. My wife and I have no debt and a net worth that exceeds $1 million. We purchased our cars with cash and the single credit card we have with a $35,000 limit is paid off in full each month. Since the foreclosure, our FICO score has been in the “fair” range. We have no plans to take out a loan for anything and plan to continue our “cash and carry” lifestyle. However, the low FICO is a little disconcerting. It appears the only cure is time (measured in years). We welcome any additional guidance.

Answer: You can’t fix your wounded FICO scores overnight, but you could speed up your credit score rehabilitation by adding one or two more credit accounts to your mix. At least one of those accounts should be an installment loan, since scoring formulas want evidence you can handle different types of credit. If you don’t want an auto or personal loan, then consider a “credit builder” loan that puts your payments into a certificate of deposit that you claim when all the payments have been made. Credit builder loans are offered by credit unions and some online lenders.

Is it worth the effort, even though you don’t plan to borrow? In most states (although not California), credit scores heavily influence what you pay for auto and homeowners’ insurance. People who don’t have the best scores can pay hundreds of dollars more each year for coverage. Credit scores also may be used to determine deposits for utilities and wireless service. If you need to rent an apartment, your credit scores matter as well.

If none of those are a concern, you can continue to take the slow road to rebuilding your credit, since the foreclosure will fall off your credit reports after seven years. If you want to speed things along, though, another credit account or two should help.

Q&A: Letting car be repossessed will make debt problem worse

Dear Liz: I own a car that I can no longer afford. Unfortunately, buying it was a poor decision and came with terrible interest rates and terms. I’ve been 30 to 60 days late on the payments for close to a year and have other debts that I haven’t been able to pay. Because of this, my credit is already in the basement. I’m underwater on the car (by about $7,000) and am feeling like the only option is to have it “voluntarily” repossessed. I really feel that if I didn’t have this $400 payment and another $200 a month in car-related costs, I could get my other debts squashed, build some savings and get in a much better place financially. I should mention that I have another (free!) car available to me when I need it and live in an area with reliable public transit, plus I have carpooling options that can get me to and from work at little to no cost. I have no major plans for anything that would require amazing credit scores. I have a stable job and rent an apartment with my boyfriend, who has strong credit but not a huge capacity to help financially. Am I insane? How would I even begin to recover from a repossession?

Answer: Having your car repossessed won’t relieve you of the debt. In fact, your debt is likely to increase.

Repossession costs such as storage, preparation for sale and attorney fees can be added to your loan balance. You’ll owe the difference between that amount and the price the creditor gets for the vehicle when it’s resold, often at auction.

If you don’t pay what you owe, your creditor can sue you — and probably will, given that nice steady job with reliable wages that can be garnished.

So yes, you probably would be insane to think repossession is the answer to your situation.

Usually the best solution when you owe more than a car is worth is to “drive out of the loan” — in other words, to own the car at least until the loan is paid off. In your case, the best solution may be to park the car while you pay it off. A parked car doesn’t need much gas or maintenance (as long as you start it occasionally). You may be able to get discounts on insurance and registration if you don’t operate it.

If you still can’t make ends meet, then get a second job that will bring in some extra cash. Pay off the loan as quickly as possible and then start saving to pay cash for your next car. Also work on repairing your credit so that if you want loans in the future you’ll be able to get decent rates and terms.