Ask Liz Weston

Get smart with your money

Credit & Debt

Q&A: Using your home’s equity to pay off credit card debt is a dumb move

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Dear Liz: My ex-husband is a self-employed carpenter who just turned 64. He’s gotten a bit over his head with his credit cards. He tried for a home equity loan since he has plenty of equity and high credit scores. His mortgage lender says he doesn’t make enough money and that he needs a co-signer.

He owes only $50,000 on the house and needs about $40,000 to pay off his bills. Why should he be punished for working hard all these years? This is crazy and stupid. Is a reverse mortgage the way to go for him?

Answer: Possibly, but it’s concerning that he has so much credit card debt. Too often people who tap their home equity to pay off debt wind up worse off in a few years. They don’t fix the problem that caused the debt in the first place, so they continue to overspend — but now they have less of a home equity cushion to fall back on in case of emergency.

That’s especially true with a reverse mortgage. These loans allow people 62 and over to borrow against their home equity without having to make payments or repay the loan until they sell, move out or die. However, any amount they borrow and don’t repay will grow over time, typically at a variable interest rate. People who use reverse mortgages to pay off debt early in retirement can wind up unable to access their equity later, when they may need it more.

The lender isn’t trying to punish your ex for working hard, by the way. It’s saying he doesn’t appear to have enough income to pay his mortgage, cover the new loan payments and take care of his other bills. Your ex may think the lender’s standards are too strict, and it’s true many lenders are more reluctant to lend to the self-employed. He may find another lender that’s more cooperative if he shops around. But that huge amount of credit card debt indicates a serious problem that needs fixing, and another loan may not be the answer.

Since your ex feels comfortable sharing financial details with you, you might suggest that he discuss his situation with a credit counselor (the National Foundation for Credit Counseling offers referrals) and with a bankruptcy attorney (the National Assn. of Consumer Bankruptcy Attorneys). Each can assess his situation and offer different potential options he could consider.

Q&A: When the path to the altar is littered with old debts

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Dear Liz: My fiancee has incurred a lot of medical debt during the course of our relationship. She works 13- to 14-hour days at two jobs so she can start saving for the wedding and our shared goals, which include buying her a car, sending me to grad school without incurring more student debt, creating a real emergency fund for us, and moving out of my apartment into a new one.

She thinks her credit is horrible (though she has never checked it) and she knows with the medical bills, it is getting worse. She doesn’t think she can move in because she can’t buy a car.

What should I do? Should I help her with her debt so we can actually plan for the wedding scheduled next July? Or should I let her deal with it herself?

My biggest concern in all of this is that I have significantly better finances. I worked hard in college and have a full-time job that pays a living wage. I’ve been in my own apartment for two years.

Sometimes I feel resentful of the fact that she cannot contribute to our household like I can, and I worry that I will have to shoulder our shared goals. I am particularly worried I will have to pay for the wedding, which I am finding more and more ridiculously expensive every day (we’re only spending $5,600), while not being able to save for grad school.

I really am not sure how to give up my frustration and face reality, and our reality is that medical debt is holding up our plans.

Answer: It’s understandable that you’re frustrated. But please don’t take it out on your fiancee, who sounds like a hard-working person who had the bad luck of getting sick.

Working 13-hour days isn’t sustainable, particularly for someone with health issues. She may already have more medical debt than she can reasonably repay, and continuing to struggle with these bills may make achieving other goals impossible.

Encourage her to make an appointment with an experienced bankruptcy attorney. Bankruptcy may not be the right choice for her, but the attorney should be able to assess her situation and discuss her options.

Her debt may be manageable with some help from you. In that case, you two need to discuss how to handle this and your finances in general.

Don’t listen to people — or your own preconceptions — telling you there’s only one way couples should handle money. Some married couples keep their finances entirely separate. Some combine everything — all assets and income are joint, and so are all debts. Most take a middle path, combining some accounts and obligations while keeping others separate.

Finances can also evolve. You may be able to contribute more now, but your fiancee may become the primary breadwinner when you start graduate school. When that happens, would you expect her to help you pay the student loan debt you acquired before marriage, or will that be your obligation?

What’s most important is that you figure out how to work as a team, without resentment and unspoken expectations. It may help to schedule a visit with a fee-only financial planner to discuss your shared goals and how you’ll fund them. You can get referrals to fee-only advisors who charge by the hour at the Garrett Planning Network, www.garrettplanningnetwork.com, and to those who charge monthly fees at the XY Planning Network, www.xyplanningnetwork.com.

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.