Ask Liz Weston

Get smart with your money

Credit & Debt

Should she use 0% credit card offer to pay student loan debt?

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Dear Liz: I currently owe $27,000 in student loans at an 11.5% interest rate. I have excellent credit and about $8,000 in savings and contribute 17% of my income to a workplace retirement plan. Should I invest less in my 401(k) and pay off debt instead? I just got a balance transfer offer for 0% for 15 months with a 3% transaction fee. I’m considering taking $3,000 and putting it toward my high-interest student loan.

Answer: If you had federal student loans, transferring any part of your debt to a credit card would be a bad idea. That’s because federal student loans come with consumer protections that allow you to reduce or even eliminate your payments if you fall on hard economic times. You certainly wouldn’t want to reduce your retirement savings to pay off these flexible, fixed-rate loans.

The higher rate you are paying indicates that you have private student loans, which typically don’t have the same protections and which usually have variable rates that will climb higher when inflation returns.

Credit card debt has similar flaws — plus you would lose the interest rate deduction on any student loans you paid off this way. Instead, you may want to investigate the option of refinancing and consolidating your private student loans with a credit union. Credit unions are member-owned financial institutions that often offer better rates than traditional lenders. One site representing credit unions, CUStudentLoans.org, currently advertises variable rates on consolidation loans that range from just under 5% to just over 7%.

If you continued to make your current payments on a consolidated loan with a lower interest rate, you would be able to pay off your loans years faster — saving on interest without jeopardizing your future retirement.

Explore other options before foreclosure

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Dear Liz: Two years ago we moved to another state. Our old house hasn’t sold in that time, as the housing market there is terrible. We have it listed for $255,000 and owe $242,000. A recent appraisal came back at $190,000 to $205,000 despite the fact that it’s in good condition and only 11 years old. We were thinking we should do a mortgage release on the property to get rid of it as we just can’t keep up the mortgage payments any longer. We didn’t think a short sale would work because there’s been no interest yet on the property. Any suggestions?

Answer: What you’re calling a “mortgage release” is actually a foreclosure, and it would devastate your credit for years to come. That may turn out to be the best of bad options, but explore others first.

Perhaps there’s been no interest in your property because the asking price is too high. Talk to a real estate agent with experience in short sales about what listing price is likely to generate offers. A short sale would hurt your credit scores, although perhaps less severely than a foreclosure if you can persuade the lender not to report the deficiency balance (the difference between what you owe on the mortgage and the sale price). The advantage of a short sale is that you’d spend less time in mortgage lenders’ “penalty box” and may qualify for another loan within two years.

Putting off retirement savings is an expensive mistake

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Dear Liz: I have about $16,000 in student loans at 6.8% interest. At the current monthly payment it would take me about 7.5 years to pay them off. I contribute 10% of my income to my company’s Roth 401(k) plan (my employer matches the first 6% contributed). I also contribute 3% to the stock purchasing plan. I am thinking of cutting back my 401(k) contribution to 6% and not contributing to the stock purchasing plan. Applying the extra money to my loans would reduce the payback period to about 2.5 years. After that, I would increase the contribution amount and diversify with a Roth IRA as well and maybe even begin the stock purchase program again. What do you think?

Answer: Not contributing to retirement accounts is usually an expensive mistake. The younger you are, the more expensive it can be.

Every $1,000 not contributed to a retirement plan in your 30s means about $10,000 less in retirement income. That assumes an average annual growth rate of 8%, which is the historical average for a stock-heavy portfolio.

In your 20s, the cost of not contributing that $1,000 is $20,000 of lost future retirement income. The extra decade of not getting those compounded returns makes a big difference.

People have the erroneous idea that they can put off retirement savings and somehow catch up later. Catching up, though, becomes increasingly difficult the longer you wait. A better approach is to save as much as possible starting in your 20s when the money has the longest time to grow. Then you’ll be in a better position to withstand job losses or other interruptions of your ability to save. If those setbacks don’t happen, you’d have the option of retiring early.

Granted, your plan would require reducing retirement contributions for just a few years. But the federal student loans you have are fixed-rate, tax-deductible debt that you don’t need to be in a hurry to pay off. In the long run, you’d be much better off boosting your retirement contributions.

If you’re determined to pay down your loans, however, use the money you’ve been contributing to the stock purchase plan. Continue making at least a 10% contribution to your retirement plan and increase that as soon as you can.

Use a credit card like a debit card to avoid debt

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Dear Liz: Here’s a suggestion for the reader who prefers a debit card to a credit card so she will not get in debt: Use your credit card as a debit card. Every month I pay any credit card balance plus an additional amount equal to a month’s average purchases. Then I keep track of what I spend so I don’t go over that amount during the billing period. This is the same as paying the bill one month ahead. I don’t go into debt at all and still get my reward points.

Answer: Another way to accomplish the same end is to check your credit card balance every week and move that amount to a savings account. When the bill is due, you can move the money back to checking from savings and pay in full. It’s important in any case to stay on top of your balances and make sure you’re not spending more than you can pay off each month.

Use inheritance to pay credit cards, not mortgage

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Dear Liz: I will be inheriting around $300,000 over the next year. My instincts are to pay down debt with this money. I have two homes and for practical reasons need to keep them. One home has a $260,000 mortgage balance at 5%. The other has a $130,000 mortgage at 4%. We have $35,000 in credit card balances. Some are telling us to invest. I think we should pay off all the credit cards and then pay down the larger mortgage by $100,000 or more. Am I on the right track?

Answer: Paying off your whopping credit card debt is a great idea. You need to figure out, though, what caused you to rack up so much debt and fix that problem. Otherwise, you’re likely to find yourself back in the hole.

Paying down a mortgage is a trickier proposition. Most people have better things to do with their money than prepay a low-rate, tax-deductible debt. Before they consider doing so, they should make sure they’re saving adequately for retirement, that all their other debt is paid off, that they have a substantial emergency fund of at least six months’ worth of expenses, and that they’re adequately insured with appropriate health, property, life and disability coverage. Those with children should think about funding a college savings plan.

If you’ve covered all these bases, then paying down and perhaps refinancing the larger mortgage makes sense.

Failed business loan strains couples’ finances

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Dear Liz: We took a home equity loan against our house to open a business in 2006. We also ran up credit card debt for the business. The business went under, and we’re struggling to pay off the loan, which is $150,000 (a $1,150 payment every month), and the credit card debt, which we got down to about $20,000 from $37,000. Is there any way to get relief from the loan since it was a legitimate business (a franchise we bought from another franchisee)? We don’t know what to do and have been taking money out of our savings to pay the debt.

Answer: Your home equity lender doesn’t care whether you spent the money on a “legitimate business” or an around-the-world cruise. The lender expects to get paid, and chances are it will, since you secured the loan with your house. Failing to pay a home equity loan can trigger a foreclosure.

If you have equity in your home, you may be able to do a cash-out refinance of your current mortgage to pay off the loan. You’d wind up with a bigger primary mortgage, but a longer payback period and a lower interest rate should reduce your total debt payments. Another option is to sell your home to pay off the debt so you can start over.

What you shouldn’t do is dip into your savings without a real strategy for resolving this debt. A session with a fee-only financial planner could help you understand your options. The planner also may suggest a consultation with a bankruptcy attorney.