Q&A: Reverse mortgage due when borrower dies

Dear Liz: I was laid off from my job this year and decided to move in with my widowed dad in the suburban home that he and my mother purchased outright in 1989. However, over the years they apparently took out a reverse mortgage with a current balance of about $500,000 (the house was recently appraised at $680,000). When my father dies, how much longer can I live in the house? If there is little or no equity left, can I walk away from the house and let the lien holder handle the sale?

Answer: Reverse mortgages, which allow people 62 and older to tap the equity in their homes, are due and payable when the borrower dies, sells the home or moves out. You won’t be expected to vacate the premises the day after he dies, but you typically would have to leave the property within six months. You may be able to get an extension of that time if you’re selling the house or trying to get a loan to pay off the mortgage.

If there is still equity left in the home, it might make sense for you to try to sell it yourself to get the maximum value. Lenders only want to recoup what they’re owed and aren’t required to go to any extra effort to maximize the amount going to the heirs.

If the home is worth less than what’s owed, you can do a “deed in lieu of foreclosure,” which essentially allows you to hand over the keys and walk away. The good news is that you’re not on the hook. Reverse mortgages are non-recourse loans, which means that the lender can’t pursue the estate or the heirs for the balance owed.

Q&A: Helping a friend build credit

Dear Liz: I am selling my car to an old friend with no credit history. (The used car salesman wanted to charge her 6.5% interest.) Is there a way that I can report her timely payments to the credit reporting services to help her build her credit?

Answer: It’s not really practical for individuals to report payments, since subscribing to credit bureaus is expensive.

The rate your friend was quoted actually isn’t bad given her lack of credit history. If she kept the loan term relatively short (four years or less), she might be able to build up enough equity and credit history to refinance it to a lower rate in a year or two.

If she’d prefer not to take that route, you might suggest she explore credit builder loans. These loans, offered by credit unions, banks and some online lenders, are designed to help establish credit histories at the bureaus. The lenders typically put the borrowers monthly payments, minus a small interest charge, into a certificate of deposit that is the borrowers to keep after the final payment.

Secured credit cards are another good way to build credit scores. Borrowers make a refundable deposit with the issuing bank and get a credit line that’s typical equal to that deposit.

Q&A: The hazards of debt settlement

Dear Liz: My wife and I owe about $46,000 in credit card debt. We are considering a debt consolidation plan in which our debt would be reduced to about $27,000. According to what I’ve read and what’s included in the paperwork, any reduction in our debt may be reported to the IRS as income. I’m assuming this would not only increase our tax burden but could result in the forfeiture of some of my Social Security benefits. Am I correct in these assumptions?

Answer: What you’re considering is debt settlement, not debt consolidation.

With debt consolidation, you get one loan to pay off other, smaller debts in full. The right debt consolidation loan would offer a fixed interest rate and would allow you to pay off what you owe within three to five years.

Debt settlement, on the other hand, means you’re trying to get your creditors to accept less than what you owe. Debt settlement typically requires that you stop making payments to your creditors, which will trash your credit scores and could lead to lawsuits. You typically accrue interest, late fees and penalties that could offset or even wipe out any savings the debt-settlement company is promising you.

And the fact that the company seems to be promising you specific results, such as a $19,000 reduction in your debt, is a red flag all on its own. Your creditors don’t have any obligation to settle with you, and a debt settlement company shouldn’t promise that it can make the debt disappear.

To answer your specific questions: Yes, any debt that is “forgiven” in a settlement is considered income that can be taxed. It isn’t considered earned income, however, and so doesn’t trigger the Social Security earnings test that can reduce your benefits.

You’d be wise to read what the Federal Trade Commission and the Consumer Financial Protection Bureau have to say about debt settlement on their sites. In the vast majority of cases, you’re better off avoiding this option. Pay off what you owe if you can. If you can’t, explore a debt management plan offered by a nonprofit credit counselor and also make an appointment with a bankruptcy attorney so you understand all your options.

Q&A: Gift tax returns

Dear Liz: You recently answered a question about gift taxes and mentioned gift tax returns. Who is supposed to report the gift, the one giving or the one receiving the money? It seems like the one receiving the gift should, but in the answer it seemed the one giving the gift was subject to taxes.

Answer: The giver would file the return. The gift tax rules require people to report any annual gift over $14,000 to any one person, although the givers don’t owe gift taxes until those aggregate amounts exceed a certain limit (currently $5.45 million). The gift tax rules are designed to keep wealthy people from circumventing estate tax laws by giving vast amounts to their heirs before they die.

Q&A: Cashing out an IRA to pay off credit card debt

Dear Liz: I owe about $49,000 on my credit cards and now have the money to pay them off in full. Should I? Or should I slowly pay them in large amounts?

Answer:
There’s typically no reason to delay paying off credit card debt. Carrying balances costs you money and doesn’t help your credit scores. You’ll see the fastest improvement if you pay them off in one fell swoop.

The only excuse for delaying would be if this windfall comes from a retirement fund. Cashing out a 401(k) account or IRA to pay off debt is not wise, since you’ll trigger huge taxes and penalties. Add in the future tax-deferred compounding you lose and the total cost is far more than you’ll save in interest.

Q&A: Tax break for helping out son

Dear Liz: Our son bought a house and lost his job two months after the purchase. We have helped him stay afloat. Thankfully he has a new job. We don’t expect to get the money back — he is still trying to get out from under — but we have given him close to $10,000. Can we claim this as a “gift” to him on our income taxes?

Answer:
The IRS doesn’t view money given to family members as a charitable donation. In other words, there’s no tax break for bailing out your kids.

If you’re so wealthy that estate taxes might be an issue — which means estates worth more than $5.45 million a person in 2016 — then you might be concerned about gift tax rules. You’re allowed to give a certain amount to any person annually without having to file a gift tax return. In 2015 and 2016, that amount is $14,000, so you and your wife together could give up to $28,000 to your son without needing to file a gift tax return. It’s only when the total value of gifts over this annual exclusion hit $5.45 million that you’d have to worry about paying gift taxes. Clearly, this isn’t an issue for most families.

Q&A: Taking Social Security at 70

Dear Liz: My husband will be turning 70 in August. Must he start taking Social Security at 70 or can he wait a little longer? He will still be earning money and if I understand correctly that will lower the amount he will receive. Does he have to do anything like apply for it or do they know he is turning 70?

Answer: He should apply for retirement benefits — online at www.ssa.gov, in person at a local office or by calling 800-772-1213 — three months before he turns 70. Benefits max out at that age, so there’s no reason to delay any longer.

The earnings test you fear only affects people who start benefits before their full retirement ages, which for your husband was 66. When you start benefits early, Social Security deducts $1 for every $2 you earn over a certain amount ($15,720 in 2016). After full retirement age, that penalty disappears.

Q&A: Financial benefits of marriage

Dear Liz: My registered domestic partner and I are both 64. We have similar incomes, similar 401(k) accounts and own a home together. We plan on retiring at 66, at which time we will also get similar Social Security benefits. We are each other’s beneficiary on all insurance, accounts, etc. My question: Now that the Supreme Court has made it legal, would it benefit us financially to get married? We’ve never felt an emotional need for that validation but are questioning whether it would make sense for other practical reasons.

Answer: When incomes are dissimilar, there’s a strong argument to be made for marriage. The lower earner may get more from a Social Security spousal benefit than from his or her own retirement benefit. In addition, the lower earner could get a much bigger survivor benefit, since a survivor gets the larger of the couple’s two Social Security checks.

If either of you had a traditional pension, a spouse would be entitled to survivor benefits that an unmarried partner can’t claim. And if you were of dramatically different ages, marriage would allow a younger survivor to put off starting mandatory withdrawals from inherited accounts.

Marriage also has estate planning advantages, but those primarily benefit wealthy couples (see above). If you do remain unmarried, you’ll want to make sure you both have powers of attorney for healthcare and finances so you can make decisions if the other becomes incapacitated.

There are many other benefits to marriage, which the self-help legal publisher Nolo has summarized at http://bit.ly/1mOmpZA. You also might want to talk to a fee-only financial planner who has experience with same-sex couples to make sure that your assets and rights are adequately protected if you remain unmarried.

Q&A: Auto loan GAP coverage

Dear Liz: In 2012, I financed a 2008 Honda at my credit union. The car was priced at $16,500. With a trade-in, the loan came to $22,000. GAP coverage was factored into the loan payments, which were $464 a month. Last year, the car was wrecked and deemed a total loss by the insurance company. They paid the “book value” of $8,860 to the credit union. However, $6,000 remained on the loan. The GAP coverage paid $3,000 and now the credit union is saying I owe the remaining $3,000. They said the GAP would only pay a percentage of the balance because the car was “over financed” back in 2012. This seems to be unfair, and I feel like the lender should get the money from the GAP provider (per the contract that was signed when the car was financed). Is it possible for the GAP provider to refuse to cover the whole balance left on the loan? I will be meeting with the loan officer next week to discuss payment options.

Answer: You’ve discovered one of the many reasons why you don’t want to roll debt from a previous vehicle into a car loan to purchase its replacement.

Many people do exactly that, though. When trading in a car for a new vehicle, nearly 1 in 3 people roll debt from the old loan into the new one, figures from car comparison site Edmunds.com show. The average amount of negative equity in January was $4,814.50. With used cars, 1 in 4 people with a trade-in roll debt from their old car into the replacement loan, with an average negative equity of $3,595.30.

GAP (Guaranteed Auto Protection) coverage would seem to be the solution, since it’s designed to pay the lender the difference between the loan on the car and what the car is worth. Most GAP policies, though, won’t cover the debt you brought over from the previous vehicle. That leaves you in exactly the position you thought you would avoid, which is having no car but a pile of debt to pay off.

A better approach to car buying is to make a significant down payment, such as 20% of the purchase price, and keep loan terms to no more than four years. You can’t buy as much car that way, but you won’t end up owing far more than the car is worth.

Q&A: Loaning money to family

Dear Liz: My cousin borrowed some money from us because he said they were behind on their house payments. It was only a small amount, but we said we wanted to sit down with him and his wife to discuss this. He agreed to meet with us in the evening of the day he received our check, but of course he called and said they couldn’t make it. We see them every week at church, and she doesn’t act as if anything was happened, while he avoids eye contact. It’s been three months and they haven’t made a single payment. I can’t imagine how I would feel if I found out that my husband was hiding something like this from me, and I don’t know if we should press the issue or just consider it a personal loss and lesson for the future. Any suggestions?

Answer: Loans to family and friends often become inadvertent gifts, so you were smart not to hand out more than you could afford to lose.

You already know everything you need to know about your cousin, which is that he lacks integrity as well as financial management skills. It’s possible that either or both of these facts would be news to his wife, but chances are good that she already knows. So there doesn’t seem to be much point in embarrassing her if you’ve already decided not to pursue the debt.