Ask Liz Weston

Get smart with your money

Credit & Debt

Should you borrow to pay a tax bill?

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Dear Liz: Help! We’ve just received devastating news from our accountant that we owe around $11,000 to the IRS and the state for 2012 taxes. The reason for the huge bill is that we cleaned out my husband’s IRA to pay for our son’s college expenses. My husband is almost 65 and working part time after being laid off, and I’m 61 with a full-time job. What is the best way to pay this bill? Here are the options I can think of: 1) Cash out my three-month emergency certificate of deposit of $12,000 that I’ve saved to cover expenses in case I get laid off. 2) Take money out of my IRA. 3) Use a credit card check that will be at zero percent for the first 12 months and then will slide to 8.9%. 4) Arrange a payment loan with the IRS. 5) Sell our house in which we have 70% equity. Which is best?

Answer: Let’s take No. 2 off the table, shall we? If you learn nothing else from this experience, it should be that tapping retirement funds can trigger a big (and often unnecessary) tax bill.

Selling your house over an $11,000 bill is overkill, so let’s eliminate that option as well. Which leads us to three remaining possibilities: Use cash, borrow from a credit card or borrow from the IRS.

Borrowing incurs costs. That zero percent credit offer almost certainly comes with a fee, which is usually 3% to 5% of the total. If you can’t pay the balance within a year, you start incurring interest charges.

The short-term rate the IRS charges for installment loans is pretty low — lately it’s been around 3% — but you also typically incur late-payment penalties. The penalty typically is one-half of 1% of the tax you owe each month or part of a month until the bill is paid in full. If you file by the return due date, that rate drops to one-quarter of 1% for any month in which an installment agreement is in effect. The maximum penalty is 25% of the tax due.

How much either option will cost you depends on how long you take to pay the bill. The cost for cashing out the CD is, by contrast, almost zero. Whatever tiny amount of interest you’re getting is far less than what borrowing would cost you. If you should get laid off before you rebuild your emergency fund, your access to cheap credit could come in handy.

Going forward, let your son pay for his college expenses and conserve what’s left of your resources for retirement.

Homeownership isn’t for everyone

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Dear Liz: I’ve gone back and forth over whether to buy property to live in. I would only consider a condo, because I don’t think it’s ecologically responsible for a single person to live in a stand-alone house, plus I have no interest in or aptitude for maintenance. But through family and friends’ experiences, I’m worried that condos can be a nightmare to own. That leaves me stuck with renting, which gives me flexibility. I also live in an extremely expensive area (Boston) and do contract work, so purchasing something I would want to live in might be tricky. But I feel I’m being barraged by people telling me that renting is a losing proposition and that buying is great for my future. I’d rather keep putting money away in my retirement funds, but I wonder if I’m just refusing to “be responsible” as others say. I have no debt at all, so I feel responsible.

Answer: You would think the recent economic unpleasantness would have cured people of the idea that homeownership is right for everyone all the time.

Real estate investors often tout the benefit of “leverage”–using borrowed money to control an asset that can appreciate in value. As we learned, though, leverage can work both ways and can leave you owing more than a property is worth.

In reality, much of the financial benefit of homeownership comes from the “forced savings” aspect of paying down a mortgage. Homes do tend to appreciate in value over time, but on average the appreciation usually doesn’t exceed the overall inflation rate. Plus homes are expensive to own and maintain, which can dramatically reduce the return on your investment. Investments in stocks and stock mutual funds probably will give you a better return over the long haul, and you’ll never have to buy a new roof for them.

Homeownership can be a good idea if you can afford all the costs, plan to stay put for several years and truly want to be a homeowner. Otherwise, renting gives you freedom and flexibility. That’s neither irresponsible nor a losing proposition.

Are student loans a bad idea?

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Dear Liz: I am a junior in college, and I might have to take out a loan my senior year because of financial cuts in the state. Is it really a bad idea to take a loan for college?

Answer: No, it’s not. You don’t want to overdose on education debt, but a student loan that helps you get the right degree could be the best investment you’ll ever make.

Someone with a college degree will earn on average $2.3 million over the course of a working lifetime, which is $1 million more than the lifetime earnings of someone with just a high school diploma, according to a study by the Center on Education and the Workforce at Georgetown University in Washington. College graduates also are more likely to stay employed. The unemployment rate for people with college degrees is about half of that for people with only high school diplomas.

Of course, you’ll want to make sure there is sufficient demand for your degree to justify the costs of your education, since all college degrees are not created equal. PayScale, a site that tracks salary information, has a report on its site called “Majors That Pay You Back” that monitors median starting and mid-career incomes for various degrees.

You’ve probably heard horror stories about people winding up with massive amounts of expensive student debt. In many cases, these scholars used private student loans, which have variable rates and lack the protections of federal student loans.

Limit how much you borrow. In general, don’t borrow more than you expect to make your first year out of school. Also, exhaust all available federal student loans before you consider a private loan. If you can work a part-time job or increase your hours to avoid a private loan, do it — but don’t work so many hours that you can’t complete your schoolwork.

A loan that helps you complete school would be far better than dropping out now, since the economic payoff from a college education requires that you actually get your degree.

Should you pay to boost your credit scores?

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Dear Liz: I’ve seen advertisements for services that promise to help you raise your credit score by the exact number of points you need to qualify for a good mortgage rate. Are these services worth the money?

Answer: There’s one thing you need to know about these services: They don’t have access to the actual FICO formula, which is proprietary. So what they’re doing is essentially guesswork.

They may suggest that you can raise your score a certain number of points in a certain time frame, but the FICO formula isn’t that predictable. Any given action can have different results, depending on the details of your individual credit reports.

Rather than pay money to a firm making such promises, use that cash to pay down any credit card debt you have. Widening the gap between your available credit and your balances can really boost your scores. Other steps you should take include paying your bills on time, disputing serious errors on your credit reports and refraining from opening or closing accounts.

Roommate may be not be telling the truth about his credit

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Dear Liz: I have a roommate who has truly bad credit. He has been turned down from getting a checking account at banks because his mom bounced checks on his account when he was 18 (he is now 31). What is the best way to rehab his credit? He can’t get a secured credit card because he doesn’t have a checking account. Is there a way around this?

Answer: You may not be getting the full story from your roommate. If his mom misused his checking account when he was 18, it shouldn’t still be affecting his ability to establish a bank account. Reports to Chexsystems, the bureau that tells banks about people who have mishandled their bank accounts, typically remain on file for only five years.

Your roommate should first request a free annual report from Chexsystems at http://www.consumerdebit.com and dispute any errors or old information. Even if he’s still listed in Chexsystems, he could get a so-called “second chance” checking account from several major banks, including Wells Fargo, Chase and PNC Bank. Responsible use of those accounts should allow him to graduate to a regular checking account. Then he can start the process of rehabilitating his credit.

What to do with extra cash when an auto loan is paid off

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Dear Liz: I’ll be done paying off my car in a couple of months. What’s a good strategy for redirecting that money once it’s paid off? Should I use the whole amount each month to start saving for my next car, or would I be better off splitting it up and putting it into several savings “buckets” such as retirement, emergency and my next car? I’m 35, have an emergency fund equal to four months’ living expenses and only one other debt, a very low-interest student loan.

Answer: If you aren’t already contributing to a retirement plan, you should be. If you aren’t contributing enough, that should be your priority even before you pay off your debt.

Market researcher and Yale University professor Roger Ibbotson has found that people who start saving for retirement after age 35 have an extremely difficult time “catching up.” They’ve lost a crucial decade or more, and often can’t set aside enough to offset their late start.

If you are on track for retirement and are comfortable with your emergency fund, saving to pay cash for your next car is a reasonable course.