Credit & Debt Category
Dear Liz: I’m a 33-year-old mother who lost my full-time job during the recession in 2009. I may have my “stuff” together again, but am considering filing bankruptcy. Each month I’m spending almost half (yes half!) of my income on debt payments to credit cards, loans and medical bills. Each month after all my bills are paid and groceries are bought, I have zero dollars left over to save. Even after losing my job, I made sure to always make those payments, so my credit is decent. Last I checked my credit score was hovering right around 700. I really have no reason to have good credit at this time, as I don’t have any need for a large purchase. Should I file or pay back my debts? Is filing for bankruptcy a good idea if it allows me to build a savings account and start putting money back into a 401(k)?
Answer: A bankruptcy filing would devastate your credit scores, and that may create more problems than you think. Credit information is used by insurers to determine premiums, by landlords to evaluate applicants and by wireless carriers and utilities to set deposit requirements.
At the same time, it makes little sense to continue to struggle against a mound of debt if you’re not making a dent in the pile. If it would take you five years or more to repay what you owe, you should at least consider filing for bankruptcy. Why five years? Because that’s how long you’d be required to make payments under a Chapter 13 repayment plan.
Most people, however, qualify for Chapter 7 liquidation bankruptcy, which is typically preferable since it’s faster (three to four months, versus five years) and erases credit card and medical bills. An experienced bankruptcy attorney can advise you and help you understand the ramifications of filing.
If lower interest rates might help you pay off your debt within five years, you also should consider an appointment with a credit counselor associated with the National Foundation for Credit Counseling (www.nfcc.org). These nonprofits can set you up with debt management plans that may offer lower rates on your credit card debt.
Most people feel an obligation to pay what they owe, but that often leads to fruitless struggles against impossible debts. Bankruptcy laws allow individuals a fresh start so that they can take care of themselves and their families. Among your many financial obligations is the one to support yourself in retirement, and every year you delay saving will make it that much harder to accumulate a reasonable nest egg.
Dear Liz: I am 48 and planning on a career change. I was looking at a culinary school website and it looks pretty exciting. It is a two-year, full-time program and the cost is about $65,000, which doesn’t cover the dorm or apartment expenses for living nearby. Of course, the institute’s counselor told me they have financial aid and asked, “How can you put a price on your future?” Right.
What would be the payback on something like that compared with an average salary of a chef? I will be 50 or so when I complete the program, and I’m not sure I want the big payment plan on my back. Can you help?
Answer: The counselor’s question is ridiculous. How can you not put a price on your future, particularly when it involves such a huge expense? Smart students consider the price not only of their educations but the incomes that education will bring them.
Many students sign up for these for-profit schools with visions of being the next Gordon Ramsay dancing in their heads. A little research would show them that this field is not exactly lucrative or booming.
According to the Bureau of Labor Statistics, the median pay for a chef or head cook was $42,480 in 2012. Employment is expected to grow 5% in the next decade, which is “slower than average for all occupations.”
So the payback isn’t great, especially if you have to borrow money to foot the bill — and most of the financial aid you get at these schools is loans rather than grants or scholarships. Even for someone with a 40-year working career ahead, taking on that level of debt isn’t smart.
You would have much less time to make an investment in a second career pay off — 15 years or so, and that’s if you can tough it out in a hot, hectic environment into your 60s.
If you really want to take this chance, at least minimize your investment by getting trained at a community college. Even better, get a part-time job in a restaurant and see how you like the work first before you commit to the field.
A more thoughtful approach to a career change would involve meeting with a career counselor to consider your strengths and experience, then looking into jobs in which those are an asset. Any training you would need should be reasonably priced and preferably something you could do while hanging on to your day job. Just think about that culinary expression “Out of the frying pan and into the fire,” and try to avoid getting burned.
Dear Liz: Our son is graduating from college and needs a car for his new job. Is this an opportunity to help him establish a good credit rating? His credit union offers loans to first-time auto buyers who don’t have a credit history, but the interest rate is 8.4% (6 percentage points more than standard auto loans). We parents intend to help pay for the car, so we could provide a larger down payment or help with larger payments to pay off the loan sooner as a way to reduce the higher interest costs. Would doing either of these, however, lower the credit rating he might earn? He has no other debt and has two credit cards (co-owned by us) on which he pays monthly in full. Are there better ways to help him establish his own credit rating?
Answer: If your son is a joint account holder on two credit cards, he might not have to bother with a “credit builder” loan. He should already have credit histories and credit scores that would qualify him for better rates.
He should first check his credit reports at http://www.annualcreditreport.com, the federally mandated site where people can check their credit histories annually for free.
If he has credit histories, he can take the additional step of buying at least one of his FICO scores from MyFico.com. (He can buy a total of three, one for each credit bureau.) There are other sources for free scores, but they’re usually not the scores used by most lenders. He then can ask the credit union for a quote on the interest rate he’d be charged, given his score or scores. It probably will be lower than 8.4% if he has a good history with these cards.
If he doesn’t have credit reports in his own name, he probably is an authorized user rather than a joint account holder on your cards. (Some issuers don’t export the primary cardholder’s history with a card into an authorized user’s credit files, although many do.) In that case, the credit-building loan could be a good idea, particularly if you were willing to help him pay off the loan quickly. Although there’s some advantage to paying off a loan according to schedule, your son will get most of the credit-scoring benefit just by having the loan, and he’ll save by paying it off fast.
Another way you could help is by co-signing the loan, but then you’re putting your credit at risk. If he makes a single late payment, your credit scores could suffer. If the credit union is willing to make the loan, that’s usually a better way to go.
Dear Liz: My credit reports don’t show any of my old unpaid collection accounts. I also have one judgment that is not showing from 2005. My wife (who has perfect credit) and I are looking to apply for a mortgage. What will the lender find? I recently applied for a credit card to start rebuilding my credit. The issuer approved me for a card with a $1,000 limit and told me my score was in the high 700s. I am so confused.
Answer: If your collection accounts are older than seven years, your lender shouldn’t see them when it reviews your credit reports. Most negative marks have to be dropped from reports seven years and six months after the date the account first went delinquent. Civil judgments also have to be dropped after seven years unless your state has a longer statute of limitations; in that case, the judgment can be reported until the statute expires. California’s statute of limitations for judgments is 10 years.
If none of those negative marks shows on your reports and you’ve handled credit responsibly since then, your credit scores (you have more than one) may well be excellent.
Since you’ll be in the market for a major loan, you and your wife should get your FICO scores from MyFico.com. Mortgage lenders will look at all six scores (one from each of the three credit bureaus for you and your wife), basing your rate and terms on the lower of the two middle scores. If that score is 740 or above, you should get the best rate and terms the lender offers.
Your FICO scores will cost $20 each, which is a bit of an investment. You can get free scores from various online sites, but those aren’t the FICO scores that mortgage lenders use and are of limited help in understanding what rate and terms you’re likely to get.
Dear Liz: I am trying to help my retired parents refinance their home. Currently they are paying over 8% interest. (This loan should be illegal.) The problem is their credit score, which is around 536. They had a tax lien in 2004 (it has been paid off for over four years) and some minor credit card issues. The total card debt is less than $1,000. I see several bad footnotes on these cards. Some of the cards have a balance of less than $100. What is the best and fastest way to help them get the mortgage they deserve?
Answer: Your parents don’t have a single credit score. They each have their own scores. Mortgage lenders typically get FICO scores for each borrower from all three credit bureaus, for a total of six scores. Lenders look at the middle score for each person and typically base rates and terms on the lower of those two middle scores.
If that number is indeed 536, your parents have serious, recent credit problems. You may not think an unpaid credit card is a big deal, but it is to credit scoring formulas, which are designed to help lenders gauge a borrower’s risk of default. People with unpaid bills are far more likely to default on a new loan than people who pay their bills on time, and their respective credit scores reflect that reality. What people “deserve” isn’t a factor. How they handle their credit accounts is.
What you’re calling “bad footnotes” are likely records of late payments and perhaps charge-offs and collections activity. Those typically can’t be erased, but your parents can stop the ongoing damage to their credit by paying their bills on time and paying off any overdue bills to their credit card companies.
If the accounts have been sold to collectors, the process gets trickier. Paying off collections typically won’t help credit scores, but lenders usually want these accounts paid off before they will make a new loan. Your parents can try negotiating to have the collection accounts deleted in return for payment, but they won’t be able to erase the late payments and other negative marks reported by the original creditor.
Once they start handling their credit accounts responsibly, their credit scores will start to improve. The improvements will happen slowly, though, and they may well miss the opportunity to refinance at today’s low levels.
Dear Liz: I am trying to increase my credit scores so I can buy a house in a couple of years. My scores are pretty bad, but I do have a car loan that I have never been delinquent on. I have recently obtained a secured credit card with a $300 limit. Will a credit card with such a small limit help improve my credit score?
Answer: Yes, but you may need longer than two years to get your scores up to snuff, depending on how bad they are.
Regaining points always takes much longer than losing them, so you should make sure to pay all your bills on time and use your new credit card lightly but regularly. Charge less than $100 a month and pay the balance in full, because there’s no advantage to carrying a balance.
After six months or so of regular payments, consider adding another card to the mix. In a year or two, you may qualify for a regular credit card that will continue to enhance your scores.
Also, make sure you’re looking at your FICO scores, because those are the credit scores most mortgage lenders use. Other scores may be offered for free or sold by the credit bureaus, but they typically aren’t FICOs.
Dear Liz: How can I get a clear and complete picture of the debts that are hurting my credit score? I have my credit report already. I’m a bit lost and I need to get my credit cleared up to buy a home.
Answer: You actually have three credit reports, one at each of the major credit bureaus: Experian, Equifax and TransUnion. Your mortgage lender is likely to request FICO credit scores from each of the three, so you need to check all three reports.
You get your reports for free at one site: http://www.annualcreditreport.com. There are many sites masquerading as this free, federally mandated site, so make sure that you enter the URL correctly. You may be pitched credit scores or other products by the credit bureaus while you’re on this site, but you won’t be required to give a credit card number to get your free reports. (If the site is demanding that you give your credit card number, you’re at the wrong site.)
You should understand that old, unpaid bills may be depressing your scores, but paying them off may not improve those scores. In other words, the damage has been done. You may be able to reduce the impact if you can persuade the collectors to remove the accounts from your reports in exchange for payment, something known in the collections industry as “pay for delete.” But you probably can’t erase the late payments and charge-offs reported by the original creditor before the accounts were turned over to collections, and those earlier marks against you are even more negative than the collection accounts.
That’s not to say you should despair. Over time, your credit scores will improve as you handle credit responsibly. But you shouldn’t expect overnight miracles.
Dear Liz: We received $100,000 from the sale of some undeveloped land. We are trying to figure out the best way to pay off our bills. Our primary residence has a balance of $173,000 at 4.25% and is a 30-year loan. We also own a home we rent out in which we cover the mortgage with the rent income. The balance on it is $131,500 at 4.5% for a 20-year loan. This home is often a burden when tenants change on an average of every 1 to 2 years, and we don’t have the income to cover the mortgage without the rental income. My husband took a $20,000 loan out of his retirement fund for closing costs for our primary residence, a debt that is being paid back through paycheck deductions. We also have an auto loan with a balance of $7,800 at 2.74% and credit cards with varying interest rates with total owing of $22,000. What should we do?
Answer: Your first task should be examining your spending habits to see why you have so much credit card debt. If you don’t fix the problem that’s causing you to live beyond your means, you’re likely to find yourself in a deeper hole eventually, regardless of how well you deploy this windfall.
You also should see if you’re on track with retirement savings. Boosting your retirement plan contributions at work and to individual retirement accounts can help you convert this money into long-term economic security.
Next, pay off the credit card debt and consider retiring the retirement plan loan. If your husband lost his job and couldn’t repay the debt, the outstanding balance would become a withdrawal that would incur income taxes and penalties.
Any money that’s left over can go into an emergency fund to protect against job loss and to keep you from going into debt between tenants. Your low-rate car loans and tax-advantaged mortgage debt aren’t top priorities for repayment, but you can start paying them down over time once your other bases are covered.
Dear Liz: I retired last year. I am 67, have more than $1 million in my retirement accounts, $80,000 in individual stocks, $50,000 in cash and more than $200,000 in equity in my home. I don’t need to tap my Social Security benefit yet and can afford to wait until I am 70 to get the maximum monthly amount. I recently purchased a new car with a 0% loan for five years. That and my mortgage are the extent of my debt. One thing I would like to do is some home improvement. My fee-only financial planner suggested getting a home equity line of credit to cover the repairs and upgrades. This makes sense to me in that it spreads out the burden over time and is tax-deductible. My credit scores are 736, 801 and 839. But I’m finding it difficult to get a commitment from either my credit union or my bank because they don’t see an income. I have been with both of these institutions for more than 30 years and the credit union holds the first mortgage. How do we get the lenders to factor retirement assets into the qualification calculations?
Answer: Last year, mortgage giants Fannie Mae and Freddie Mac issued guidelines on retirement fund annuitization that would allow mortgage lenders to calculate a borrower’s income based on his or her retirement assets.
Lenders, however, have to be willing to go to a little extra effort to learn the rules and apply them properly.
If yours aren’t willing to do so, then it might be time to take your business elsewhere. A mortgage broker (referrals from http://www.namb.org) may be able to connect you with a lender who’s more up to date.
Dear Liz: My wife of 34 years died five years ago. Her father is 94. He has accumulated a large amount of wealth over the last 40 years. I always made a point of staying out of financial discussions between my father-in-law and his daughters. He told us for years that upon his death all his wealth is to be divided between us (my wife and me) and her sister. Recently, a gold digger reappeared on the scene. My father-in-law and his late wife took her in at a young age when her parents died. I don’t know if she was ever formally adopted or not, or how that affects the situation. My question is, do I have any legal rights, upon my father-in-law’s death, to any distribution of his estate if I am not listed in the actual trust or will?
Answers: Your chances of inheriting from your father-in-law may have died along with your wife.
Sons-in-law don’t really have inheritance rights. If your father-in-law dies without an estate plan, state law would dictate who his heirs would be: typically his surviving spouse (if he has one) and any living children. Even his kids would have no legal right to inherit if he has a will or trust that disinherits them.
Estate plans sometimes make provisions for a child’s spouse, particularly if the money eventually will be inherited by the grandchildren. Such a trust might give you the right to income from assets that on your death would go to your wife’s children, for example. If there aren’t grandchildren, though, the money your wife would have inherited may simply go to her sister (and possibly the “gold digger,” as you describe her, if she’s included in the estate plan).
Of course, if the old man likes you, he could make a bequest to you in his will. But you have no legal right to demand that he do so, and any attempt to pressure him could raise the question of who is the actual gold digger here.
Moving student loan debt
Dear Liz: My daughter has $30,000 in student loans from obtaining her masters degree. The loans have about a 7% interest rate. She will be eligible to have $5,000 forgiven if she works five years in a low-income school. Although she is currently so employed, she does not know whether she will stay there for five years. I have a line of credit available with a 4.8% interest rate. It seems to me that she will pay less overall if she uses my line of credit to pay off her student loans and makes the monthly payment on the line of credit. Does she miss out on developing a good credit score by using my credit? Is it worth paying the higher interest rate to develop that credit history?
Answer: There are several reasons not to use your credit line, and they don’t have to do with her credit scores.
The student loans are helping her scores now and will continue to do so even after they’re paid off, since most lenders continue to report closed accounts for years.
If she uses your line of credit, though, she won’t be able to deduct the interest she pays. Student loans provide a valuable “above the line” income adjustment for most borrowers. They don’t have to itemize to take advantage of this adjustment, which is the smaller of $2,500 or the interest actually paid. The ability to take this tax break is phased out in 2013 when modified adjusted gross income is between $60,000 and $75,000 for singles and $125,000 to $155,000 for married couples filing jointly.
Also, your line of credit carries an adjustable rate that can (and likely will) go higher. The rate would have to rise only two percentage points before it equals the fixed rate on her federal student loans. Federal student loans offer a number of other protections, including income-based repayment options, forgiveness after 10 years in public service jobs (after 25 years otherwise) and forbearance or deferral should she experience an economic setback. She can learn more about these options at studentaid.ed.gov.
Finally, if she failed to make payments on your line of credit, your credit scores would be on the line — as would your home, if the account is secured by your home equity.
It’s commendable that you want to help your daughter, but in this case you both may be better off keeping the debt in her name rather than putting it in yours.