Credit Score Issues
Q: Since completing a Chapter 13 bankruptcy eight years ago, I've raised my credit score from 300 to 689, bought a house and a used car, and saved $10,000. But recently, two collections for forgotten medical bills hit my credit report and dropped my score by more than 80 points. Should I drain my savings to pay off my debt?
A: I generally encourage people to make good on debts when they have enough money to repay them. But once a delinquency has been reported to a collection agency, paying it off won't help your FICO score. The damage has already been done, and the blemish will remain on your credit report for seven years.
At this point, I'd recommend that you negotiate with the debt collector so you can repay a smaller amount and keep more of your savings. Creditors will often accept far less than what is actually due. One important caveat: When you negotiate a lower payment, the IRS usually counts the forgiven amount (what you're not required to pay) as income, which means that you'll owe taxes on that money.
Q: I've got $17,000 in credit card debt, $21,000 in student loans, a car payment and an interest-only, variable-rate home loan that will adjust in two and a half years. I take in about $37,000 annually. How will I ever be able to save for today, for retirement, for my sons' futures? Where do I begin, and how do I prioritize?
A: Your overriding goal must be to stay current on all your monthly debt. Pay at least the minimum amount due on your credit cards each month, and keep up with the car payment. That should result in a strong credit score, which means you may be able to ask to have your cards' interest rates reduced.
Next, I want you to consider selling your home and moving into a rental. Next, ask your mortgage lender what your payment would be if the adjustment hit today. If the answer scares you, I want you to consider selling. If you can sell and make enough to cover your mortgage and moving costs, I suggest you do it now. The move will give you a better grip on tomorrow by reducing your costs today. Assuming that renting will free up some money, I want you to open two accounts that will help you establish peace of mind: an emergency cash fund and a Roth IRA. When you find full-time work in your chosen field—and you will, stay positive—you can revisit buying a home.
Q: My husband and I are working our way out of more than $14,000 in credit card debt. (We didn't pay our bills until we were about to be sued.) We've settled one balance for $9,000, and we're in the process of reducing another one. How can we remove these blemishes from our credit reports and improve our scores fast?
A: Your settlement was merely the second strike to your credit—the first was your delinquency. Honestly, I wouldn't look for a quick fix for your score right now. A higher number might give you easier access to money through extended credit card limits or better loan terms, but you and your husband need to focus on living within your means and examining why you accumulated so much debt in the first place. If you don't deal with the issues that caused you to overspend, you'll just repeat your mistakes.
Ultimately, your score should improve if you maintain a debt-to-credit ratio below 30 percent and pay every bill on time. (Go to MyFico.com to learn more about factors that can affect your credit score.) Unfortunately, there's no way to know exactly how long it will take to repair the damage, but stay vigilant—you'll get there.
Next: How to plan your way out of debt
How to Tackle Credit Card Debt
Q: Though my husband and I are struggling to pay off our $4,000 credit card debt, he contributes the maximum amount to his IRA—$5,000 per year, or $417 per month; the account is now worth $19,000. I think he should suspend his IRA contribution until we're debt-free. He thinks the IRA is more important. What are your thoughts?
A: Though I love that your husband is so focused on saving for retirement, you're right to want to get out of debt ASAP. But you're viewing this as an either/or proposition, when you actually have several options.
First off: If you suspend that $417 contribution and put it toward your credit card instead, you could be out of debt in ten months. That's a fine solution. But you could also put money toward both goals. Assuming your credit card carries an 18 percent interest rate, and you're making a minimum required payment of just 2 percent of your balance, your monthly payment is about $80. Continue paying $80 a month, and it'll take seven years to be out of debt. You'll also pay almost $3,500 in interest. Increase that to $375 by contributing $122 a month to the IRA instead of $417, and you'll have the debt paid off in one year—while still saving nearly $1,500 for retirement during that time.
But I think the best idea is to see if you can qualify for a new credit card that will charge you 0 percent interest on the transfer amount for the first 12 months. (Search for deals at CreditCards.com.) Pay about $330 a month, and you'll have the balance down to zero within the year. One caveat: Use a transfer only if you won't be charged a balance transfer fee, which could be 4 percent of your transfer amount. Try a credit union credit card—many don't charge these fees.
Finally, you referred to your husband's IRA—but I hope you have a spousal IRA as well. Even if you don't have a paying job, all spouses are eligible for an IRA—provided that the spouse with an income earns income at least equal to the annual contributions. (So if a married couple both contributed $5,000 to an IRA, one spouse would need to earn at least $10,000.) Make sure you're protecting your future just as diligently as your husband is protecting his.
Q: After taking out cash advances on her credit cards, my 81-year-old mother is out $8,000. She lives on $600 a month from Social Security and cannot keep paying on this debt. Can you advise me on how to proceed? How do I get her out of credit card debt?
A: As daunting as an $8,000 debt looks, I'm relieved the figure isn't higher, given your mother's generous nature. A cash advance on a credit card is one of the worst types of borrowing because the interest rate is typically 21 percent or more. It's fruitless to try to talk your way out of this; the card issuer has every right to expect repayment.
To regain control of her debt, have your mom keep paying at least the minimum due on the monthly credit card bill. On-time installments are vital for protecting her FICO credit rating. That's important because if her score is at least 700, she has a good chance of being able to transfer the entire balance to a new card with a lower interest rate. Many card issuers offer zero percent interest for the first year when you move your balance to their card. At CardTrak.com, click on Credit Cards, then choose Balance Transfer to find issuers offering the best deals. But only sign up for one card—multiple applications made at the same time can actually hurt her credit score.
Next: Find out which bills and debts to prioritize
Prioritizing Your Payments
Q: My husband and I are at a crossroads. We expect that the company I work for will pull out of our area and I'll be laid off. We've been saving diligently, putting money away every month to keep us afloat while I'm between jobs. Then we realized we have enough in our savings account to pay off all our debts (cars, campers, one credit card) except for our mortgage. Doing so would free up about $2,000 a month. Should we pay off everything and begin saving again or keep the money in the bank for the probable end of my employment?
A: Pay off the credit card, but don't pay off the cars and campers. I firmly believe that everyone needs to make it a priority to get out of credit card debt (see Preparing for a Possible Layoff). But you also need to keep enough money in your savings account to cover the mortgage payments if you cannot quickly find another job. If you deplete your savings to pay off the cars and campers, how will you be able to make the house payments if you are laid off?
That said, what you really need to consider is selling one or more of the cars if you can pocket enough to cover the loan balances on the vehicles. And those campers fall far short of being a necessity, so you might think about selling them, too. I know that getting rid of certain possessions is hard to contemplate, but hard times require sacrifices.
Q: My husband has a structured settlement from an accident he was involved in as a child. He sold ten years of that settlement in 2004, but in 2014 he'll start receiving monthly payments of $400. We have approximately $30,000 of debt, including medical bills, and we lease our only vehicle. These days we are having difficulty making payments on time. There is literally $1 in our savings account. We have a 7-month-old son and hope to buy a house within the next few years. We think that selling the rest of the settlement to pay off our bills will allow us to save for the home of our dreams. There's about $110,000 left; by selling it, we'd net $17,500. Would that be smart?
A: Structured settlements are a common way for people who have been injured to receive an insurance payout. The periodic payments provide ongoing income and reduce the risk of blowing a lump sum through poor financial choices. In many states, you can sell your rights to periodic payments to a company that will pay you a lump sum today. Doing so, I realize, is tempting, but it's typically not smart.
For starters, payments received in a structured settlement are generally tax-free; if you sell in return for a lump sum, you may owe state and federal tax, thus reducing the settlement's value. More important, the firms that buy your settlement are out to make money by underpaying you for its real value. The bottom line: Cashing out today can mean netting far less than you'd get if you kept the payments.
Let's do the math. Since you owe $30,000, a $17,500 payout isn't going to solve your problems. You would still have $12,500 in debt, and a car lease, and you'd be no closer to building a savings account, let alone coming up with the down payment for a home. I want you to dig out of debt without touching the settlement money. Your dream should be to get out of debt, not to buy a home that you have no way of affording right now.
If you need help tackling your bills and learning to live within your means, I suggest you contact the National Foundation for Credit Counseling, a nonprofit organization that will connect you with a debt counselor in your area. NFCC counselors will assess your situation, help you negotiate payment plans with your creditors when feasible, and, yes, tell you if cashing in your settlement is your best move.
I also want you to focus on what those tax-free settlement payments can do for you beginning in 2014. It sounds as though you have 20 more years of payments coming to you. If you were to invest the entire $400 every month in a Roth IRA for 20 years and earn a conservative 5 percent annual return, you would have about $165,000 in 2034. If you were to keep that sum growing for another 15 years—without investing another penny—you could have more than $340,000 by the time you retire. That's a dream that can be yours if you use the structured payouts wisely.
Q: After college my fiancé and I lived abroad and worked as much as possible. We started sinking into debt, and it took a while to get reestablished Stateside. Finally, we found a house, and though it wasn't expensive, my husband wasn't earning much. His salary has steadily increased to $120,000, but we are nearly $100,000 in debt in addition to our mortgage. The cost of living in our neighborhood is high, and my own contributions have been sporadic because I care for our two children and two ill relatives. We have a 401(k) and life insurance but no savings, and we often bounce checks at the end of the month. We have already borrowed against our house as much as we can. My husband gets frantic and doesn't want to spend at all, even for the kids. I feel bitter and shop anyway because it seems as if we'll always be broke no matter what. I'm afraid to open our bills. The panic is starting to affect our marriage. Is there any way to achieve financial equilibrium?
A: There's no reason you can't get by on your husband's salary. The problem is that you're sabotaging your family. I know that sounds harsh, but you need a serious financial wake-up call, and I'm sounding the alarm. Part of the reason you're doing this is that you're overwhelmed from taking care of everybody else. Subconsciously or not, you believe nobody is taking care of you. So you fill that hole by spending money, and then you feel terribly guilty. You deserve to treat yourself better than that.
Use your fear of opening those monthly statements as motivation to change. Whenever you're about to whip out your credit card for another unnecessary purchase, ask yourself: "Is this worth the horrible feeling I'm going to have when the bill arrives?" Keep a photo of your family next to the credit cards in your wallet; as you reach for one, think about whether the item is worth the possibility of losing their respect or, in the case of your husband, losing your spouse completely. That's where this is headed if you don't change. I know you have it in you to make the right choice.
Next: The ins and outs of a second bankruptcy
How to Handle Bankruptcy
Q: I filed for bankruptcy in 1998 after a divorce. I started to rebuild my credit, but then, because of an illness that had me in and out of the hospital, I went from earning $23 per hour to earning $9. As a result, my finances are in the dumps. Creditors are calling me at home and at work threatening to garnish my wages. I will soon start a $15-an-hour job, but I need some time to get control of my finances. I want to remove my name from the house I bought with my current husband and file for bankruptcy again. Please help me start over.
A: The first step in starting over is standing up for your rights with the debt collectors. As I explain in "Dealing With Debt Collectors," strict federal and state laws prevent debt collectors from harassing you. And they can garnish your wages only if they take the time to sue you in court and get a judge to issue an order. Right now they are winning at the game of making you panic. Don't let them. Stay calm, know your rights, and then focus on developing a strategy to get out of debt.
Bankruptcy may well be the answer, but first you and I need to have a talk. I am sympathetic to the fact that an illness threw a wrench into your financial life, but it worries me when someone angles for a repeat trip to bankruptcy court. So many people who get into trouble once fall into the same predicament again. Please promise me that you truly are committed to starting over and building a more solid financial life for yourself. That takes time, effort, and good money habits. Without all three, you will keep finding yourself living on the edge.
Because the last time you filed for bankruptcy was 14 years ago, you are technically allowed to do so again. The law states that if you previously received a discharge of debt in a Chapter 7 bankruptcy (in which the majority of your debts can be wiped out by a bankruptcy judge if you meet certain income tests), you can refile after eight years. You may file for Chapter 13 (in which you commit to a repayment plan for some debts) every two years. To learn more, go to the American Bankruptcy Institute's Consumer Bankruptcy Center.
However, I also want you to explore other options. Contact the National Foundation for Credit Counseling to talk with a counselor in your area who can help you devise the best strategy for dealing with your debt. Starting over begins with taking control. Don't panic...instead, prepare yourself by knowing your options.
Suze Orman's latest book is The Money Class: How to Stand in Your Truth and Create the Future You Deserve (Spiegel & Grau). To ask Suze a question, go here.
More Advice from Suze Orman
- Suze answers your top real estate questions
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- How to know you're ready to save for a house