Ask Liz Weston

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Credit & Debt

Settling co-signed student loan debt

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Dear Liz: My daughter co-signed a student loan for a friend who failed to pay the debt. Now my daughter cannot refinance her home because this loan appears on her otherwise very good credit reports. She has been getting calls from a collection agency.

I called the agency to discuss what it would cost to get her released from all liability regarding this loan, and they gave me an offer of $13,000 to satisfy the debt, which is now $35,000. I countered with $9,000, since the original loan was just $15,000, but they refused. My daughter is unhappy about paying anything, since her ex-friend is a gainfully employed attorney. Is it good business to pay what the collection agency is asking, or should I continue to negotiate?

Answer: That sounds like a pretty good offer, said financial aid expert Mark Kantrowitz, publisher of the FinAid and Fastweb websites.

“Lenders almost never settle for less than the outstanding principal balance of a defaulted student loan, so that may be the best she can get,” Kantrowitz said. “It may be the case that they are offering her a low settlement amount to release her from her obligation and then will go after her former friend for the remaining debt. When there are two borrowers on the hook, one borrower reaching a settlement does not cancel the debt. It merely releases that borrower from her obligation.”

Your daughter should have the settlement offer reviewed by an attorney, Kantrowitz said. The attorney should verify that the collection agency has the authority to settle the debt, and any agreement should list all of the loans involved.

“I’ve seen cases where a borrower thought she was getting a settlement of all the loans,” Kantrowitz said, “but the settlement was just for some of the loans.”

Ideally, the settlement agreement would require the lender to stop reporting the default and delinquencies to the credit bureaus, which would remove the stain from her credit reports. Not all lenders will agree to such a condition, Kantrowitz said, but removal would be better for her credit than simply having the debt reported as “satisfied.”

Also, the agreement should require that the lender provide a “paid in full” statement to your daughter as proof her debt has been settled, Kantrowitz said.

“She should keep this statement forever,” Kantrowitz said, “as defaulted loans have a tendency to resurrect themselves from time to time, [such as when] a bank reloads their database from old backup tapes [or] someone reviewing old records discovers the original promissory note.”

An attorney also could advise your daughter about taking further steps, such as suing the former friend for repayment or reporting the issue to the state bar, which has standards of professional conduct that may be violated by an unpaid debt.

Skip a payment, trash your scores

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Dear Liz: We are trying to negotiate our second mortgage and have not paid it since June. Will this affect my wanting to purchase an auto?

Answer: It may not affect your desire to purchase a car, but it’s likely to affect the actual transaction if you’re not able to pay cash.

Failing to pay a credit obligation can devastate your credit scores, the three-digit numbers lenders use to gauge your creditworthiness. The worse your scores, the less likely you are to find a lender willing to do business with you. Even if you can secure a loan, it’s likely to come with a scandalously high interest rate.

Getting help with a soon-to-be unaffordable mortgage

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Dear Liz: I have an excellent credit rating, a steady job and an interest-only mortgage of $480,000 on a home now worth $400,000. I also owe $52,000 on an adjustable-rate home equity line of credit. In 2015, the interest-only portion of my loan ends and the principal payments will start, driving my payment to more than $4,000 a month. I have tried for the last four years to work with the lender to achieve some manner of stability, but to no avail. I have been told that my first loan has been sold to an outside investor. Is there any hope for me? I like my house.

Answer: If you haven’t already done so, you should make an appointment with a housing counselor approved by the U.S. Department of Housing and Urban Development. You can find referrals at http://www.hud.gov, or you can call the Consumer Financial Protection Bureau at (855) 411-CFPB (2372) to be connected to a HUD-approved housing counselor.

Housing counselors can evaluate your situation and offer guidance about any programs that might be available to help you refinance or modify this loan. You also should pick up a copy of attorney Stephen Elias’ book, “The Foreclosure Survival Guide,” so you can better understand this process and whether it’s worth fighting to save your home.

HUD-approved housing counselors offer free or low-cost help. Beware of anyone who promises to help you for a fat fee, because it’s probably a scam.

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.

“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.