Incomes don’t count in credit scores

Dear Liz: I have high student loan debt. When I pull my FICO scores from Equifax and TransUnion, the only thing that’s keeping my scores low is that I have a 99% debt-to-income ratio on my student loans. The length of credit history and payment history are fine. I have two credit cards and I use 20% or less of the credit limits, paying in full every month, but I still have mediocre scores of 620 to 680. What to do in this situation?

Answer: Income is not a factor in calculating your FICO credit scores, so your debt-to-income ratio wouldn’t affect your scores. What you may be referring to is your credit utilization — how much of your available credit you’re using. While high utilization of credit cards and other revolving accounts can hurt your scores, it’s unlikely that high balances on installment accounts would be enough of a negative to make your scores so low.

What you need to do is pull your credit reports and examine them closely to see what’s wrong. You may have late payments or collection accounts you don’t know about, or you could be the victim of identity theft.

Don’t borrow for an education you can’t afford

Dear Liz: My son will be going to a for-profit technical school about 120 miles away from home. Unfortunately, we have not saved any money for his college education. What are our best options for borrowing to pay for his college education, which will cost about $92,000 for four years? He is not eligible for any financial aid other than federal student loans. Our daughter will graduate debt free with her bachelor’s degree in December. Since we concentrated on her education first, our son kind of got left behind.

Answer: Please rethink this plan, because your family probably cannot afford this education.

Federal student loans would allow your son to borrow, at most, about a third of this school’s cost. If he were to borrow the rest of the money, he would have to turn to private student loans, which have variable rates and none of the consumer protections embedded in federal student loans. Private student loans are like using credit cards to pay for college — except unlike credit card debt, student loan debt can’t be discharged in bankruptcy.

The other alternative would be for you to borrow the difference between his federal student loans and the cost of his education using PLUS loans. These are federal education loans for parents and graduate students. As with federal student loans, the rates for PLUS loans are fixed, although they’re somewhat higher — 7.9%, compared with 6.8% for unsubsidized Stafford student loans.

But using PLUS loans means taking on a lot of debt at a time in your life when you should be concentrating on saving for your own retirement. If making the payments would interfere with your ability to contribute sufficiently to your retirement funds, you shouldn’t even consider borrowing the money.

Even if you already have a well-funded retirement plan, you should think twice. Your son may be able to get a better, more affordable education from a public college — particularly if he starts at a two-year community college nearby, allowing him to live at home more cheaply, and then transfers to a four-year school.

For-profit colleges can be expensive, and loans made to students who attend four-year for-profit colleges have twice the default rates of loans made to other college students. Figures provided by the U.S. Department of Education show that of loans that entered repayment in 1995, 30% of those made to students attending four-year for-profit colleges were in default 15 years later, compared with 15.1% for four-year public colleges and 13.6% for four-year private nonprofit schools.

That high default rate should give you pause, even if you were paying cash for this education, because it indicates that many graduates either aren’t finishing their educations or aren’t finding jobs that pay well enough to repay their loans.

Critics complain that for-profit schools often over-promise and under-deliver when it comes to training students for existing jobs. The for-profit schools attribute high default rates to the demographics of their students, who are more likely to be lower income and from minority groups than other college attendees.

You may feel guilty for shorting your son when it came to saving for college. But please don’t compound the problem by blessing an education that could leave him, and you, with unaffordable debt.

Money priorities: Put retirement savings first

Dear Liz: It’s still not clear to me how I should prioritize saving for retirement, paying down (massive) student loan debt and buying or building a modest house, even though I have read a number of your articles and answers to many other readers’ questions. Once I pay off what is left of my credit card debt and build up an emergency fund, what then? Do I put retirement first, paying down student loans second and a modest house last? Or should I pay my student loans last — for instance, by opting for an income-based repayment rather than the higher, regular payment amount and going for the house instead?

Answer: You should put retirement saving first now, even before you pay off your debt. If you don’t get a relatively early start putting away money for retirement you’re unlikely to be able to catch up later. Those who start saving after age 35 have a very tough time putting away enough money to comfortably retire, says Roger Ibbotson, founder of Ibbotson Associates financial research firm and a Yale School of Management professor. The ideal time to start saving for retirement is with your first job.

Prioritizing retirement means you’ll have less money for other goals, so paying down your debt and building up an emergency fund will take longer, but so be it. The amount of extra interest you pay on your debt will be overshadowed by the tax breaks and investment gains you’ll make in the long run in your retirement accounts.

After paying off your credit card debt, your next goals will depend on your individual situation. If all your education debt is federal student loans rather than private loans, then you needn’t be in a rush to pay it off. That’s because federal student loans have relatively low, fixed rates and many flexible repayment options. You also may qualify for student loan forgiveness in 10 years if you work in public service or 25 years if you don’t. An income-based repayment plan would allow you to minimize your payments so you could put money toward other goals. You can research your repayment options at FinAid.org, a financial aid and student loan education site.

If, on the other hand, you have some private student loans, you’ll probably want to make paying that off a priority since the rates are variable and you don’t have as many repayment options. (You probably wouldn’t be able to make income-based payments, for example.)

When to prioritize a home purchase depends, again, on your individual situation. If you’re sure you’re where you want to be for the next 10 years or so and are eager to own a home, you could start a down payment fund as soon as you finish paying off the credit card debt.

Degree from for-profit school leads to big debt

Dear Liz: I’m going to owe nearly $40,000 in student loans when I graduate in the spring with an associate’s degree in political science with paralegal studies as my major. I’m attending an online university. Is this debt worth it, and is the school I’m attending credible enough for employment? I’m very worried.

Answer: You should be. You’ve borrowed a small fortune to get a two-year degree that would have cost about $5,000 at your local community college. For-profit institutions, like the one you’ve chosen, are coming under increased criticism for using taxpayer-subsidized loan programs to boost their revenue while not always providing valuable or high-quality educations to their students.

The Government Accountability Office was concerned enough about reports of deception that it sent undercover investigators to 15 for-profit colleges and discovered that all 15 misled potential students about their programs’ cost, quality and duration. Recruiters at four of the colleges encouraged the investigators to lie on their financial aid forms. (Most for-profits depend heavily on federal aid in the form of grants and low-interest student loans.)

The GAO study was followed by a report in August from the U.S. Department of Education, which found that nearly two-thirds of the students who borrowed to attend for-profit schools weren’t repaying their federal loans. By contrast, the repayment rate for private nonprofit schools’ borrowers was 56%, while 54% of those who borrowed to attend public schools were in repayment mode.

You might want to talk to your local junior college to see whether any of your credits will transfer and whether you might be able to finish up your education for less. If not, lean on your school’s placement office to help you find a job. You’re graduating into a tough economy with an overpriced degree of unproven value, so you’re going to need all the help you can get.

How to tackle overdue bills

Dear Liz: My finances have been on the rocks for six years. I have a defaulted student loan, credit card debt, bounce fees from checking account overdrafts and money owed for utilities. I’m a single mom and recently moved back in with my parents. I finally saved enough money to buy a car with cash, because whoever looks up my credit laughs. It’s so bad, I wouldn’t give myself a loan. READ MORE