Consider your options before settling debt

Dear Liz: My wife and I have never recovered completely from my being laid off a couple of years ago and then taking a job at a much lower salary. Because of late charges, over-limit fees and higher interest rates, we never seem to make any progress in getting out of old debt. We have just been offered a settlement amount by one creditor on a debt for some windows. It will reduce what we owe from about $7,500 to about $1,900. With a 30% interest rate and over-limit fees each month, we were getting nowhere in paying this off. Should we accept this offer? Our credit scores are already shot.

Answer: If you can’t pay off the debt and your scores are already in the tank, a settlement can seem tempting. But there are some things you should know.

Your scores probably will suffer further damage, because a settlement is considered a major black mark on your credit.

Also, the forgiven debt may be reported to the Internal Revenue Service as taxable income to you, which would increase your tax bill. Some creditors have been known to sell the unpaid debt to collectors, so you would want to be sure to get the creditor’s promise in writing that the debt won’t be resold.

If this settlement will help you pay down your other debt, it might be worth doing. If, on the other hand, you’ll still be overwhelmed, you might be better off filing for bankruptcy instead. Bankruptcy could wipe out your consumer debts, such as credit cards, personal loans and medical bills, allowing you to get a fresh start.

Before you accept this settlement, consider talking to an experienced bankruptcy attorney about your options.

Using cards as an emergency fund can hurt your scores

Dear Liz: Help! In the last year, my credit scores have dropped 30 points. I don’t know why except that my credit reports noted that I used 10 credit cards recently. (I’ve had many dire emergencies lately, but I paid off all my balances as usual.) I’m terrified of more drops. What can I do?

Answer: Build up your emergency fund.

Because you charged your emergencies, you used up more of your available credit. The more of your credit you use, the more negatively your scores tend to react. It doesn’t matter that you paid your balances off each month. What counts is the balances that your credit card issuers report to the credit bureaus, which are typically the balances on your latest statements.

Now, the good news is that your scores probably will recover as soon as you start charging less. But you should take this as a sign that credit cards are a poor substitute for savings. An emergency fund could help you survive life’s inevitable setbacks without having to run to your cards.

Marriage doesn’t combine credit scores

Dear Liz: I have reunited with the love of my life. There is one problem: She has a bankruptcy on her record. If I have very strong credit scores and we marry, how will her credit affect my chances of buying a house?

Answer: You each will retain your individual credit reports when you marry. They won’t be combined.

If you plan to use her income to help qualify for a home purchase, though, her credit scores will be used to determine the rate and terms you get. If the bankruptcy is recent or if she hasn’t taken steps to rehabilitate her credit, that means you could pay more interest or have more trouble finding a loan.

If you don’t need her income to qualify, on the other hand, her credit troubles don’t need to affect your loan.

How teenagers can build credit

Dear Liz: You recently wrote that adding a child as an authorized user on the parent’s credit card can help your children with their credit scores.

This didn’t work for my daughter. She has been an authorized user for a few years and is trying to get her own credit card and can’t, because she has no credit reports or credit scores.

It is a shame that the honest people suffer for what has happened recently in the financial world and now young people who will pay their bills don’t even have a chance! She even has her own checking account and that doesn’t help. She is now 19.

Any advice on where to go or what to do?

Answer: The financial crisis and credit crunch have made it tougher for many people to get credit, but your daughter still has plenty of options.

You first should call the credit card company and ask if it will export your good history with the credit card to your daughter’s credit bureau files. Not all issuers will do so, but it doesn’t hurt to ask. If this issuer won’t export the data, check with your other card issuers to see if they will.

If that doesn’t work, your daughter can get a secured credit card to help build her credit history. Borrowers make a deposit with the issuing bank of $200 to $1,000 and get a card with that much credit. She can find secured card offers at www.cardratings.com and www.creditcards.com.

She should use no more than 30% of her credit limit at any given time and pay off her balances in full and on time every month.

She also might consider getting a personal loan to help build her credit. Credit unions tend to be more flexible about helping their members get started with loans, so encourage her to look into joining one of those if she’s not already a member. (To find credit unions to join, visit www.joinacu.org.)

Parents: Here’s an easy way to build your kid’s credit

Dear Liz: My credit scores are good (over 800 when I refinanced my mortgage last year). I was thinking of listing my son, who is 14, as an authorized user of my credit cards to start establishing his credit history. Will it work? Is there any other way to help him? If it is too early, when is a good time to start?

Answer: As long as you handle your credit cards responsibly — using 30% or less of your credit limits and paying on time — adding your son as an authorized user could indeed help him build his credit history.

This is important, because under the credit card reform law that goes into effect in February, people younger than 21 will have a much harder time getting credit cards and thus building credit on their own. Yet they will need good scores to get apartments, good insurance rates and decent loan rates when they leave the nest.

Adding a child as an authorized user to a card is a low-risk way to build his credit since you don’t have to give him the card or access to the account. Instead, your history with the card is simply added to his credit reports, assuming your credit card issuer agrees (call and make sure first; some issuers report authorized-user information only for spouses). All versions of the leading FICO credit scoring formula factor authorized-user information into their scores, although the latest iteration — FICO 08 — limits how many authorized-user accounts are included.

When you decide to do this is up to you. A longer credit history is generally better, but you should add him only when and if you’re comfortable doing so.

If you decide to do this, discuss with your son the reasons why and also take the opportunity to talk about responsible use of credit. Make sure he knows the importance of paying all balances in full every month and how carrying credit card debt is foolish and expensive. He may not be using the card now, but he’ll have his own credit soon enough, and it’s never too early to instill the importance of using cards as a convenience rather than a crutch.