Ask Liz Weston

Get smart with your money

Liz Weston

How to keep mortgage debt from wrecking your retirement

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Dear Liz: I have a first mortgage with a current balance of $32,000 at 5.625% interest. This will be paid off in about 24 months, based on regular payments plus $200 a month extra I am paying on principal. I have a home equity line of credit with a balance of $200,000 at 3% interest on which I am paying interest only ($490) monthly with an occasional principal payment when I can afford it. Between the two mortgages I am making payments of about $1,950 per month.

I am about to retire and want to reduce my payments to a more manageable amount. I do not intend to move in the near future. Income is $145,000 annually now but will be reduced to about $76,000 annually upon retirement. Should I just hold on, pay off the first mortgage and then begin making interest plus principal payments on the credit line? Or should I refinance both mortgages now into a 30-year fixed mortgage?

Answer: Ideally, you would retire your mortgage debt before you retire from your job. That’s not possible in your case, so you should focus on making sure this debt doesn’t wreck your retirement.

A spike in interest rates could play havoc with your budget. Mortgage interest rates have been extremely low for some time, but that won’t continue indefinitely. Inflation may pick up as the economy improves, which means that 3% variable rate on your home equity line of credit could march considerably higher.

Consider locking in today’s low mortgage rates with a 30-year, fixed-rate mortgage. You could get an even lower rate on a 15-year mortgage, but the payment would be significantly higher — about $1,600 a month on a $232,000 mortgage, compared with about $1,000 a month for the 30-year loan. You may prefer the flexibility of the 30-year loan, which would still allow you to make extra principal payments to pay off the loan faster without locking you into a higher monthly payment.

Huge debts? Where to find help

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Dear Liz: My husband and I are in a huge amount of debt. I understand that there are nonprofit agencies that can sit down with us and help us develop repayment plans and strategies. How do I find a reputable one?

Answer: Contact the National Foundation for Credit Counseling at (800) 388-2227 for a referral to a legitimate, accredited, nonprofit credit counseling agency in your area. A counselor can review your financial situation, help you with budgeting and see whether you’re a candidate for a debt management plan, which would allow you to pay off your credit card debt over time, perhaps at a lower interest rate.

You also should consider making an appointment with an experienced bankruptcy attorney. You can get referrals from the National Assn. of Consumer Bankruptcy Attorneys at http://www.nacba.org. A credit counselor may try to steer you away from bankruptcy, whereas an attorney can let you know if it might be a better option.

Unfortunately, many people wait too long before they contact a credit counselor. They may be approved for a debt management plan but find themselves unable to stick with the plan long enough to pay off their debt. In other words, they continue to struggle with debt that they ultimately can’t pay. Understanding all your options, including bankruptcy, can help you make a better choice about what to do next.

Does giving up your land line hurt your credit scores?

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Dear Liz: I recently heard that not having a land-line home phone number can hurt your credit score because it indicates instability. Is this true? I, like many people, use only my cellphone and no longer have a land line.

Answer: The answers to most credit scoring questions are complex because the formulas are complex. In this case, though, the answer is simple. What kind of phone you use is not a factor in your credit scores.

Credit scores are based on the information in your credit reports, which typically doesn’t include information from telephone companies unless you’re applying for a new account (in which case a credit inquiry may appear) or seriously delinquent in paying your bills (in which case a collection account may appear).

Lenders typically use other criteria in addition to your credit score to evaluate your application. Those criteria may include your income, your debt-to-income ratio, how long you’ve worked for your current employer and other information that’s not part of the credit scoring formulas. So it’s conceivable a lender might prefer people who have land lines, but with so many people using cellphones only, that lender would certainly be behind the times.

Capital gains boost income tax bracket

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Dear Liz: You recently wrote about potential capital gains on the sale of a property that was a gift from the parents (“Gifting home creates unnecessary tax bill“). The husband of the seller made $75,000 a year in income and the seller didn’t work. Isn’t it true that if his taxable income remains in the 15% bracket (taxable income of $70,700 or less), they would owe no capital gains tax, at least as it stands for 2012? With standard deductions, he would fall into the 15% bracket.

Answer: It’s true that the capital gains tax rate is zero for people in the 10% and 15% income tax brackets. But the amount of capital gains is added to your other income to determine your bracket.

“The $75,000 of current income plus $85,000 of gain would put them well into the 25% tax bracket and subject to the 15% capital gain rate,” said Mark Luscombe, principal analyst for tax research firm CCH. “A standard deduction of $11,900 plus a couple of exemptions of $3,800 each for 2012 could make part of the $85,000 gain taxed at a 0% rate, but the bulk of it would be taxed at the 15% capital gain rate.”

“Compassionate review” may lead to student loan discharge

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Dear Liz: We have a family member who recently was approved by Social Security for a complete disability claim. This person will never work again but has an outstanding student loan. The lender has a formal mechanism to apply for loan forgiveness, but is refusing to accept medical documentation of the disability. What appeal process is there and how can we force them to act? Do we need to retain legal counsel and incur additional expense to enforce a legal process and achieve loan forgiveness?

Answer: Federal student loans offer a “total and permanent disability discharge” that forgives outstanding education debt. You can find the rules and an application at DisabilityDischarge.com.

The rules for private student loans, however, vary by lender. Four lenders — Sallie Mae, New York Higher Education Services Corp., Discover and Wells Fargo — offer a discharge for total and permanent disability that is similar to the federal one, said Mark Kantrowitz, publisher of the FinAid.org and FastWeb.com financial aid sites. The Sallie Mae discharge is also provided on loans made through lenders that market the Sallie Mae loans, such as Commerce Bank, Fifth Third Bank and Regions Bank, Kantrowitz said.

Other lenders do not offer such a discharge, but all have a compassionate review process for their private student loans, he said.

“Borrowers in a difficult financial situation, or their family or other representatives, should contact the lender that holds the loan directly,” Kantrowitz said. “The call center staff are not always familiar with the compassionate review process.”

Lenders are generally more likely to cancel some or all of the debt, or at least reduce the interest rate, in a situation that permanently affects the borrower’s ability to repay, Kantrowitz said. They are less likely to make an adjustment when the loan was cosigned and the cosigner is capable of repaying the debt.

“But it varies,” Kantrowitz said. “I’ve seen some cases in which the borrower was military and killed in action where the lender forgave the loans even though the cosigners were capable of repaying the debt. Another example involved a mother whose daughter dropped dead on an athletic field and the mother’s anguish was palpable in the letter to the lender.”

Debt cancellation comes with another issue: taxes. Forgiven debt is typically treated as taxable income by the IRS. Your family member may be able to avoid the taxes if he or she is insolvent, but a tax professional should be consulted.

Why college is more expensive now

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Dear Liz: Thank you for your response to the reader who complained that college students who received student loans were getting a handout. You did a great job of highlighting the challenges today’s students face, but you didn’t talk about the main underlying cause. This is the defunding of state universities by state governments. In Oregon, for example, the state has gone from funding over 50% of the costs to current funding of 6%. The difference has been made up by tuition hikes and increasing the proportion of out-of-state (and foreign) students who pay much higher tuition. This is part of the reason that students are crowded out of classes. In Oregon, the medical school found it was better off giving up all state aid and going it alone. Other universities in Oregon are considering taking the same action. Schools founded with state money and supported for years with tax money will no longer be operated for Oregon students. They will be more like private schools, perhaps moving out of the reach of middle-class students. So the answer to the reader is that she did get government help to get through school, help that is now curtailed so students have to finance it themselves.

Answer: The reader didn’t specify what type of college she attended. But the withdrawal of state government funding in recent years has definitely made public college educations more expensive for many students. Meanwhile, many private schools have expanded their financial and merit aid budgets so that some students can attend a private college at a lower net cost than what they would pay for a public school.