Should you refinance a mortgage that’s almost paid off?
Dear Liz: We have a second home close to a lake that we bought in 2002 for $370,000. It could have sold for $1 million at the peak of the market but is now worth about $800,000. We owe $100,000 on a mortgage with four years left until it’s paid off, but the payments are a hardship and barely manageable. I don’t expect prices in the area to improve much in the next several years and they may decline more. Since I could sell the house now and get back all the money I ever put into it, I figure that every dollar I pay on it from now on is a dollar of profit burned. Selling the house is not an option, though, as my wife is adamant about keeping it. We are 10 years from retirement and have a kid to put through college. Our income is just under $100,000, we have no other debts and our primary home is paid off. Should we refinance the remaining balance to a 30-year loan, or just grin and bear it until the payoff in a few more years?
Answer: If you’re on track saving for retirement and your child’s college education, then the smart thing would be to gut it out and get the property paid off. You’re so close to the end of this loan that the majority of your payments go toward principal. Refinancing might lower your payments, but would dramatically increase the amount of interest you’d pay over time.
If you’re stinting your savings, though, the math gets more complicated. You could view the paid-off vacation home as an asset you could tap later for retirement expenses or college. In that case, getting it paid off on the current schedule would make sense. If selling or borrowing against the home in the future isn’t an option, though, then lowering your payments so you can save for your other goals starts to make some sense.
If that’s the option you choose, consider a 15-year loan rather than a 30-year loan. The shorter loan will still dramatically reduce your payment but you’ll pay about 60% less interest over time.
Budgeting in the big city
Dear Liz: You’ve written about the 50/30/20 budget structure that people should strive to achieve. As you said, it’s a difficult feat. But here’s my question: How does one even come close when you live in a major metropolitan area? In my particular case, home values in my area have remained intact in many places and demand for apartments is so high that vacancy rates are the lowest in the nation. To get into a relatively safe neighborhood with access to public transit, rent is over $1,000 with a roommate or two. Finding that 50/30/20 balance seems impossible for people who live here and we can’t all just relocate.
Answer: If you live in a high-cost area but don’t have a high income, you’ll need to get creative if you want to keep your “must have” expenses—shelter, food, transportation, child care, minimum loan payments and insurance—under 50% of your after-tax income.
Many people in high-cost areas devote 40% or more of their incomes to shelter costs, which makes it all but impossible to have enough money left over for their “wants” (clothes, vacations, gifts and other non-necessities that should consumer 30% of their after-tax incomes savings, according to the 50/30/20 plan) or savings and debt repayment (which should consume 20% of your after-tax income under the plan). The result is a perpetually unbalanced budget, which often leads to more debt and lots of anxiety.
But people have come up with various solutions to better balance their budgets. Blogger Donna Freedman was an apartment manager for several years, which helped lower her shelter costs. Fred Ecks, who retired in his 40s, lived on a boat to reduce his rent in notoriously high-cost San Francisco. Other people have exchanged their services for free or reduced rent—by babysitting or serving as a companion to an elderly person.
If you can’t find a solution that lowers your housing costs, you have two options: continue to live with a lopsided budget, and accept that you may never be able to achieve a balanced financial life, or move to a place where you can make the math work.
Should you stay in debt to help your scores?
Dear Liz: I have a high-interest car loan (more than 10%) and just landed a part-time job to add to my full-time cash flow. I want to pay the car off as quickly as possible, but I have read and been told that paying a loan off early doesn’t help scores as much as paying the duration of the loan. Is there truth to this? It seems foolish, though, since won’t I be paying more interest?
Answer: The primary concern with paying off a loan is that the lender may stop reporting the account to the credit bureaus. Although there are limits to how long most negative information can stay on a credit report, there are no limits to how long good information can or must be reported.
Still, most lenders continue to report accounts that have been paid off for several years. If you can pay off a high-rate loan, you probably should, and trust that you’ll get “credit” for your on-time payments for years to come.
Mom stole college fund. What to do?
Dear Liz: What recourse would my 21-year-old nephew have if his mother embezzled his college fund? The fund was set up by his parents when he was a child.
Answer: If your nephew wants to try to sue his mother, or file a criminal complaint against her, he should talk to an attorney about his options. Money that’s placed in a trust or custodial account for a child’s benefit is no longer the parent’s to take, although too many parents don’t understand this and grab at an easy source of funds when money gets tight.
In the more likely case that he doesn’t want to take formal action against his mother, he could simply ask her to return the money she took. His chances of success may not be great — people who steal from their kids may not be eager to make amends — but he likely stands no chance if he doesn’t ask.
Bankruptcy may be the best of bad options
Dear Liz: I am having a terrible time with my finances. I am a single woman with no kids, and I work as a teacher at a charter school making $40,000 a year. I am working with a debt management program to pay off my credit cards. But I am constantly late in paying my bills and often bounce checks, which costs me money I don’t have to cover the fees. I can’t even save. I’m actively seeking another job or an additional part-time job, but no luck so far. I am in default on my student loans (they want me to pay $700 a month, but I can’t). I am very depressed and am so tired of this. I have holes in my tennis shoes and I can’t afford new ones. I am on a strict budget, I use coupons, don’t go out much anymore (which makes me more depressed because I am cooped up all the time). I have house problems that I need to deal with but can’t. I hate living like this. I honestly don’t know what to do. Please help.
Answer: The first thing you need to do is opt out of your bank’s bounced-check protection program. You may think you need to borrow money this way to make ends meet, but as you’ve discovered, it’s driving you further into the hole.
Next, rethink your participation in the debt management program. It was honorable of you to try to avoid bankruptcy, but it’s pretty clear you can’t afford to continue with this program if doing so leaves you in default on your student loan obligations. Credit card debts can be erased in Bankruptcy Court; student loan debt can almost never be wiped out that way.
If you have federal student loans, you may be able to qualify for the income-based repayment program, which caps your payment at a reasonable amount and erases any remaining balance after 10 years in a public service job (such as teaching in the public school system). Otherwise, the balance is erased after 25 years of payments. If you have private loans, you have far fewer options for repayment, but wiping out the credit card debt would free up more money to pay these loans back. Talk to your lenders to see what options you may have.
Another factor to consider is how much you’re spending on housing. If you own a home, the mortgage and related home-owning costs may simply be too much for you on your current income. Getting rid of the house in a short sale, or even letting it go into foreclosure, may be a far better option than continuing to cling to a home you can’t afford.
Bankruptcy, short sales and foreclosures are all drastic options. But some financial problems are so great that a drastic solution is the only reasonable choice if you ever want to get back on your financial feet.
