Ask Liz Weston

Get smart with your money

Credit & Debt

Q&A: Do credit scores punish you for not carrying debt?

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Dear Liz: I am fortunate to be able to afford homeownership without having to obtain a mortgage. The same is true of owning cars without a car loan. I pay my credit card bills in full each month. In short, I do not carry any debt.

However, it seems to me that I am being “punished” by not carrying a load of debt. My credit score is reduced by this lack of debt and I am wondering why this is.

Answer: The most commonly used credit scores don’t “know” if you’re carrying credit card debt or not. The balances used in credit score calculations are the balances the card issuers report to the bureaus on a given day (often your statement balances). You could pay the balance off the next day, or carry it for the next month, and it would have no impact on your scores.

A small part of credit scoring formulas measure your mix of credit, or whether you have both revolving accounts (such as credit cards) and installment loans (mortgages, car loans, student loans, etc.) You may get higher scores if you added an installment loan to your mix. If your scores are low, it can be worth adding a small personal loan to boost them. If your scores are good, though, it may not be worth the effort and interest expense.

Q&A: One spouse’s debts might haunt the other after death

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Dear Liz: I have a terminal illness and have less than a year to live. My wife and I are in our 80s and don’t own anything: no cars, no homes. My wife has an IRA worth $140,000 that pays us $2,000 a month, and she has a small pension of $1,400 a month. We receive $3,900 from Social Security, for a total monthly income of $7,200.

We have $72,000 in credit card debt that is strangling us. I told my wife that after I’m gone she should simply ignore that debt and advise creditors that I have passed away. Or should we attempt to file bankruptcy now?

Answer: Your return address shows you live in California, which is a community property state. Debts incurred during marriage are generally considered joint debts, so expecting creditors to go away after your death is not realistic.

Your wife’s retirement also could be at risk because California has limited creditor protection for IRAs. Federal law protects IRAs worth up to $1,283,025 in bankruptcy court, but outside bankruptcy, creditor protection depends on state law. In California, only amounts “necessary for support” are protected.

You really need to consult with a bankruptcy attorney to discuss your options. You can get referrals from the National Assn. of Consumer Bankruptcy Attorneys at www.nacba.org.

Q&A: Credit freeze may be inconvenient, but it’s effective

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Dear Liz: Is freezing one’s credit reports the safest bet even though it’s inconvenient to get it temporarily unfrozen? Plus you have to pay a fee. At my son’s urging, I had my credit reports frozen since the Equifax incident but I find it very inconvenient whenever some financial firms need to look into my credit score.

Answer: Credit freezes remain the best way to prevent new account fraud, which is when criminals open up bogus credit accounts in your name.

It is somewhat inconvenient to have to remember to thaw the freezes when you apply for credit or other services, and you have to keep track of the personal identification numbers (PINs) that allow you to do so.

The good news is that the fees for instituting and thawing freezes will go away as of Sept. 21. The Dodd-Frank reform that Congress passed this spring included a clause requiring credit bureaus to waive those fees.

Q&A: When buying a car, be strategic with your money. Here’s how

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Dear Liz: My son, 27, has a 2009 car that needs a new engine and is not running. The engine would cost $6,100 to replace, which is money he doesn’t have. He owes $10,000 on his car loan at 6% interest. The car would be worth only about $4,500 if it were running.

Should he sell the car to a junkyard for $200? Should he refinance the car loan for the remaining months he’ll make payments and also try to get the interest rate reduced?

He also wants to buy a 2016 car for around $18,900. He needs the car to get to work every day. Should he buy this car and have two car loans? Or should he look for an older car for now, until he gets the “upside-down” loan paid off?

Answer: It’s unfortunate that your son’s response to overspending on one car is to overspend on a replacement.

Let’s go over some basics of smart vehicle ownership. In general, we should avoid borrowing money to pay for assets that lose value — and a car is pretty much the definition of an asset that loses value. New cars depreciate by about 20% as soon as you drive them off the lot and lose roughly half their value in the first three years. The vast majority continue losing value until they’re sold for scrap. Only a handful of classic cars ever appreciate.

That means paying cash for cars is usually the smart move. Since most people can’t swing that, at least at first, the next best policy is to make large enough down payments so the cars we buy aren’t upside down, or worth less than what we owe.

When people are upside down on vehicles, the best practice is typically to “drive out” of their loans. That means continuing to make payments until they own the cars free and clear. Ideally, they would then keep the cars until they’ve saved enough to make substantial down payments on the replacement vehicles or buy a replacement outright.

Pouring more money into this particular car probably doesn’t make much sense. Your son probably won’t be able to refinance, since he has no equity in the vehicle. He might be able to roll the negative equity into a loan on a new car, but that would leave him in an even worse financial position: more deeply upside down and probably paying a higher interest rate.

Your son should consider getting a personal loan, perhaps from a credit union, to pay off the balance. Instead of spending nearly $20,000 on a 2-year-old replacement, he should aim to spend $3,000 to $5,000 on a good, reliable older car. If he can pay cash, great. If not, he should work to get both loans paid off as quickly as possible and start saving for the next car.

Q&A: Does a credit freeze hurt your credit scores?

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Dear Liz: I implemented a credit freeze a few months ago. I’m wondering if that could prevent me from having credit scores. I understand that if you don’t use credit, your credit scores can basically go away. I don’t have any loans or a house payment. I do have a few credit cards, used often and paid in full monthly.

Am I at risk of my credit fading away because of neglect with the freeze in place?

Answer: You’ll continue to have credit scores as long as you keep using credit accounts that are reported to the major credit bureaus. The people who are at risk of having their credit die of neglect are the ones who stop using credit.

About 7 million people are considered “credit retired,” which means they no longer actively use credit enough to generate credit scores, according to credit scoring company FICO. Their histories are free from charge-offs and other negative marks that might indicate their lack of credit is involuntary, says Ethan Dornhelm, FICO’s vice president for scores and predictive analytics.

Being credit retired can be costly. People may be shut out of loans they want in the future, or may have to pay higher interest rates. A lack of scores could lead to higher insurance premiums, cellphone costs and utility deposits.

Keeping your credit scores alive is relatively easy — using a single credit card is enough. There’s no need to carry debt or pay interest. Just continue using the card lightly but regularly, and pay it off in full every month.

Your credit freezes will prevent new lenders from seeing your scores and opening new accounts in your name unless you thaw the freezes. Companies where you already have an account, however, will be able to see your reports and scores.

Q&A: The dark side of reverse mortgages

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Dear Liz: I have had a reverse mortgage on my condo since 2009, due to financial necessity. The interest rate on my mortgage keeps going up. Could the interest rate be reduced by changing lenders or would there be exorbitant fees involved in the process? My financial standing is not good, and I am in credit card debt. However, I do pay the minimum payment each month on each card. Being retired, I need some guidance on relieving the financial pressure I am currently experiencing.

Answer: Please consult a bankruptcy attorney.

Changing reverse mortgage lenders would indeed involve considerable expense and wouldn’t relieve any financial pressure because you don’t have to make payments on this kind of loan. (For those who don’t know, reverse mortgages allow people ages 62 and older to tap their equity in a lump sum, through a stream of monthly checks or via a line of credit. The debt grows over time, typically at a variable interest rate, but the borrower doesn’t have to make payments. The loan is repaid when the borrower moves out, sells the home or dies.)

If you can pay only the minimums on your credit cards, you probably have more debt than you’ll be able to repay. Some people manage to dig themselves out of such debt, often by working two jobs and dramatically cutting their expenses. They may use a debt management plan offered by a credit counselor to reduce their interest rates. Sometimes they sell their homes and use the equity to pay off the debt.

You can explore these options, of course, but chances are they won’t be a solution for you.

You may not be able to find a job, or have the stamina to work. Selling your home to pay off the debt would leave you without a house in your old age and may leave you without income, if you’re getting monthly checks from your reverse mortgage. If you borrowed a lump sum instead, your debt may have grown to the point where you don’t have much equity left anyway.

Your situation is one of the reasons many financial planners are leery about reverse mortgages. They can be an extremely helpful tool in retirement, but sometimes people use them as a way out of a financial jam without addressing the spending or other issues that got them into the jam in the first place.