Ask Liz Weston

Get smart with your money

Real Estate

Q&A: How a short sale can short-circuit your credit score

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Dear Liz: In 2010 I was laid off from my construction management position. I was unable to find work for 28 months. The bank tried to foreclose but I was able to arrange a short sale of my home in March 2012. Shortly after that, my unemployment benefits ran out and I was unable to pay my obligations (two credit cards totaling around $9,500).

I did get a good job in June and in July worked out payment plans to get the back debt caught up. I have since paid this debt off (November 2016) and pay any credit card balances in full every month. I also pay my car loan on time using automatic debits.

My credit scores remain stuck in the 675 to 690 range and none of the steps that I take seem to help. I know that after seven years the negative information regarding the mortgage and the credit card past dues will drop off. Since I did the short sale and not a foreclosure, though, why are my credit scores treating me as if I did a foreclosure or chose bankruptcy?

Answer: A bankruptcy theoretically slices more points off credit scores than either a foreclosure or a short sale. The hit you take from a short sale, though, depends in part on how your lender reported the transaction to the credit bureaus.

If the lender reported a deficiency balance — which is essentially the balance of your mortgage that wasn’t repaid after the sale — the impact will be similar to a foreclosure. If the lender opts not to report the balance, the credit score impact will be somewhat less. After the foreclosure crisis started, some lenders opted not to report those balances as an incentive for homeowners to arrange short sales rather than let their homes go into foreclosure.

You’re already doing most of what you need to do to repair your credit, including having different types of credit (credit cards are revolving accounts while car loans are installment accounts) and paying those debts on time.

One tweak you can try is reducing your credit utilization on those cards. If you regularly charge 30% or more of your credit limits, try reducing your charges to 10% of those limits or less. It’s good that you pay in full, but the balance that’s used in most credit scoring formulas is the one the credit card issuer decides to report. It’s often, but not always, the amount that shows as your balance due on the statement closing day. Reducing the amount of credit you use may boost your scores a few more points. Other than that, you simply have to wait for time to pass and for your responsible credit use to undo the damage of the past.

Q&A: Capital gains tax on home sale profit

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Dear Liz: I recently sold a home and am trying to escape the dreaded capital gains tax. I’ve done everything I can to reduce my overall tax bill, including maxing out my retirement contributions. I don’t want to buy a more expensive home to escape the gains tax. Any thoughts?

Answer: Buying a more expensive home wouldn’t change what you owe on your previous home. The days when you could roll gains from one home purchase into another are long gone.

These days you’re allowed to exclude up to $250,000 in home sale profit from your income (the limit is per person, so a couple can shelter $500,000). In other words, that amount is tax free, as long as you lived in the home for at least two of the previous five years. Beyond that your profit is subject to capital gains taxes. The top federal capital gains rate is 20%, plus a 3.8% investment surtax if your income is more than $200,000 for singles or $250,000 for married couples.

Here’s where good record-keeping may help. While generally you’re not allowed to deduct repair and maintenance costs from that profit, you can use home improvement expenditures to reduce the tax you owe. Home improvements are added to your cost basis — essentially what you paid for the property, including settlement fees and closing costs, and that’s what is deducted from your net sales price to determine your profit.

You’ll need receipts plus credit card or bank statements to prove what you paid. Improvements must “add to the value of your home, prolong its useful life, or adapt it to new uses,” according to IRS Publication 523, Selling Your Home. Examples of improvements include additions, remodels, landscaping and new systems, such as new heating or air conditioning systems. You can include repairs that are part of a larger remodeling job, but you can’t include improvements you later take out (such as the cost of a first kitchen remodel after you do a second one).

Q&A: Parking money for a short term

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Dear Liz: We will soon be selling our home and moving into an apartment until we purchase a new home. Our proceeds from the sale will be over $600,000. It seems that there is no place to safely put the funds and get some meaningful interest to boot. Savings accounts and money markets pay very little interest, and certificates of deposit have a fixed time. We may need to withdraw the money in as few as 30 days, but it may be six months or longer. Any suggestions where to park our money?

Answer: Some online banks currently offer interest rates around 1% for savings accounts. It’s not much, but it’s better than the 0.06% rate that’s currently the national average, according to the FDIC’s April 3 report. An Internet search for “best savings rates” should turn up competitive offers.

A rate of 1% isn’t much and means that you’ll lose a little ground to inflation, which is currently more than 2%. But it’s more important that your money be safe and liquid, ready when you need it, than for you to try to squeeze a high return from it.

Are you buying a house or lottery ticket?

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The same week legendary investor Warren Buffett put his California vacation house on the market, a friend told me her widowed mother had sold the family home in Cleveland.

Buffett bought his Laguna Beach place in 1971 for $150,000 and is asking $11 million. My friend’s parents bought their home for $24,500 in 1965 and just sold it for $104,000. Put another way: If Buffett gets his asking price, his house will have appreciated at an annual rate of 9.79 percent. The Cleveland house eked out a 2.82 percent annual return.

Neither buyer could have predicted what their homes would be worth now. One could score a healthy return, while the other didn’t even keep up with inflation. (If she had, her home would have been worth about $190,000.) In my latest for the Associated Press, how purchasing a home could be a gamble.

Q&A: Deploying a windfall wisely

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Dear Liz: I recently received a $38,000 windfall. I have a student loan balance of $37,000. I want to buy a home, but I can’t decide if I should have a large down payment and continue paying down student loans slowly, or make a balloon payment on my student loans and put down a smaller amount on the home. The mortgage rate would be around 4% while the student loans are at 6.55%. The price of homes in my area is at least $250,000 for a two-bedroom house (which my income supports). I want to make a smart decision.

Answer: At first glance, the answer may seem obvious: Pay down the higher-rate debt. But a deeper look reveals that the second option may be the better course.

Student loan interest is deductible, so your effective interest rate on those loans may be less than 5%. If they’re federal student loans, they have all kinds of consumer protections as well. If you lose your job, for example, you have access to deferral and forbearance as well as income-sensitive repayment plans. In most cases, you don’t need to be in a rush to pay off this tax-advantaged, relatively low-rate debt.

A home purchase may be more time sensitive. Interest rates are already up from their recent lows and may go higher. If you can afford to buy a home and plan to stay put for several years, then you probably shouldn’t delay.

A 10% down payment should be sufficient to get a good loan. You’ll have to pay private mortgage insurance, since you can’t put 20% down, but PMI typically drops off after you’ve built enough equity. You usually can request that PMI be dropped once you’ve paid the mortgage down to 80% of the home’s original value. At 78%, the lender may be required to remove PMI. (Note that these rules apply to conventional mortgages and don’t apply to the mortgage insurance that comes with FHA loans.)

You can use the remaining cash to pay down your student loans, but do so only if you already have a healthy emergency fund. It’s smart to set aside at least 1% of the value of your home each year to cover repairs and maintenance, plus you’ll want at least three months’ worth of mortgage payments in the bank. Even better would be enough cash to cover all your expenses for three months.

Q&A: The new reverse mortgage is safer but still expensive

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Dear Liz: If you have never written about the new reverse mortgages, please consider it. I’m nearly 90 and this Home Equity Conversion Mortgage sounds too good to be true. Is it? I’ve talked to a broker and a direct lender and attended a two-hour seminar on the subject.

Answer: Reverse mortgages once deserved their bad reputation, but changes to the Federal Housing Administration’s HECM program in recent years have made them safer and less expensive. They’re still not a cheap way to borrow, though, because of significant upfront costs. Using a home equity loan or line of credit is often a better option if you can make the payments.

A reverse mortgage may be an option if you can’t make payments. These loans allow you to tap the equity in your home if you’re 62 or older. The amount you borrow plus interest compounds over time and is paid off when you die, sell or permanently move out. You can get the money as a lump sum, in a series of monthly checks or as a line of credit you can tap.

The older you get, the more you can receive from your home — but you can’t get the money all at once, as you could in the past. If you choose the lump sum option, you can only access 60% of your loan amount the first year. This restriction was put in place to keep you from blowing through your equity too fast.

While reverse mortgages have improved, some of the people touting them have not. Investment salespeople and scam artists sometimes try to push older people into reverse mortgages as a way to come up with cash to invest in their schemes.

You’re required to get counseling from someone approved by the U.S. Department of Housing and Urban Development to discuss how reverse mortgages work and how much one may cost you. In addition, consider hiring a fee-only financial planner to give you advice.