Pay off debt or save more for down payment?

Dear Liz: Next year we will be shopping for a house in the $150,000-to-$200,000 range and hope to have $20,000 to $30,000 saved for a down payment. We have about $75,000 in student loans we are paying down. Would it be better to eliminate, say, one $3,000 student loan early or keep the $3,000 for a bigger down payment?

Answer: Eliminating such a small loan is unlikely to have a big effect on the size of the mortgage you’ll get, so you’re probably better off boosting your savings for your down payment. Don’t forget to save a bit extra so you have enough cash to cover closing costs and the inevitable repairs and maintenance required with homeownership.

Short sale causes credit scores to plunge

Dear Liz: Do I need to stop making payments for my bank to consider a short sale? I moved and put my house on the market a year ago with no bites despite three price reductions. The only way I’m likely to sell it is to reduce the price below what I owe the lender. I want my credit to remain as good as possible, but worry that if I have to miss payments to get the lender to consent to a short sale my scores will be lower than if I had kept up the payments before selling short.

Answer: Lenders have different policies on short sales, which is when they agree to let a borrower sell a home for less than what is owed on the mortgage. You’ll need to talk to yours about what’s required. But expect your credit scores to take a major hit, whether or not you stop payments first.

A short sale typically will have exactly the same impact on your credit scores as a foreclosure, according to Fair Isaac, the company that created the leading credit scoring formula, the FICO. Fair Isaac recently released a chart showing the effects of various credit score blows, from a missed mortgage payment to a foreclosure or a short sale with a deficiency balance (which is the difference between the home sale proceeds and what you owe). Someone with FICO scores in the 780 range would lose 90 to 110 points with a single skipped payment. A short sale or foreclosure would trim 140 to 160 points from that 780 score. (You can see the charts at Fair Isaac’s Banking Analytics Blog, http://tinyurl.com/3eze2a5.) Your score will plummet that far whether or not you stop making payments before the foreclosure or short sale.

You might be able to reduce the damage from a short sale if you can convince the lender not to report the deficiency balance to the credit bureaus. Short sales without a reported deficiency balance would trim 105 to 125 points from a 780 score, according to Fair Isaac. But lenders who’ve been cajoled into a short sale often aren’t in the mood to grant you additional favors.

There are some advantages to a short sale over a foreclosure. One is that you can start the long road to credit recovery sooner, since foreclosures usually take much longer than short sales. The other bit of good news: you can qualify for another mortgage faster. Lenders typically will consider you for a home loan two years after a short sale, versus a wait of up to seven years if you let the current lender foreclose.

With retirement, there’s no making up for lost time

Dear Liz: You say that retirement saving should always come first. What if I have no debt except a mortgage and am paying into retirement and college savings plans, but also choosing to accelerate my mortgage payments? I’m 40 and will pay off my mortgage in two years. I could probably do better by putting the extra principal payments into retirement funds, but psychologically it feels great to pay off the mortgage. I plan to accelerate my retirement saving after paying off the mortgage. What do you think?

Answer: There’s nothing wrong with paying down a mortgage as long as you’re saving enough for retirement and your other important financial goals.

The problem comes when people skimp on their retirement savings, thinking they can make up for lost time later. They typically can’t, and the longer they delay adequate contributions to their retirement, the more hopelessly behind they fall.

Nagging lender drives borrower nuts

Dear Liz: Our mortgage is due on the first day of each month. A late fee is due if the payment is received by the mortgage company after the 16th. The mortgage company calls me if they have not received the payment by the fourth. I hung up on them the last time they did it. They followed up with a letter about getting debt crisis counseling (which didn’t go over real well in my household). Are they allowed to harass me if they don’t get their payment in four days? What about the grace period? Can they report my payment as late?

Answer: Let’s tackle that last question first. Most creditors don’t report a late payment to the credit bureaus until the account is 30 days or more overdue. If you make a mortgage payment within the grace period, you shouldn’t have to worry about damage to your credit scores.

You may, however, have to put up with the calls and suggestions about credit counseling. Many lenders and loan servicers these days are using various software programs to gauge the ongoing risk a borrower may default and are trying to step in early when red flags pop up. Your mortgage company could be singling you out for special attention for a variety of reasons. Perhaps you’re underwater on your home, owing more than the property is worth, and the lender is afraid you’ll walk away. Other factors that could trigger a call include a history of late payments, rising debt on other credit accounts or a drop in your credit scores.

It’s also possible that your mortgage servicer is just being paranoid and harangues every borrower who doesn’t pay on or before the due date.

You have a few choices. You can write to the servicer and ask it to stop contacting you during the grace period, but there’s no assurance the calls will stop. You can ignore the calls. Or you can move up your payment to land on or before the first of the month.

Property loss may lead to bankruptcy

Dear Liz: I recently lost a rental property to foreclosure, and the lender is after me for the difference between what I owe and the sale price of the property (roughly $58,000). If I am sued, is there any way to get out of this debt without paying?

Answer: If you are sued by this or any other lender, you should consult an experienced bankruptcy attorney about your options. If you can’t afford to pay a deficiency judgment — the difference between what you owe and what the property is worth — bankruptcy could allow you to erase or reduce the debt.

Although some states, including California, protect homeowners from such lender lawsuits, the protection does not extend to rental or commercial property. It can also be waived, inadvertently or otherwise, when a homeowner signs lender documents to arrange a short sale. Anyone who is selling an underwater home or who is in danger of losing one to foreclosure should discuss the situation with an attorney familiar with real estate and bankruptcy laws.