Talking Money: Learn When, Where and How to Scrimp

Posted: Aug 26, 2009 5:42 PM

It's Q&A time again! Even if your question didn't make it into this round, I think you'll find these few tips will help as we all continue to weather this economy.

Q: I will be laid off on at the end of this month, and will have about six months of severance pay. Should I take out a loan from my 401(k) now, while I'm still employed, to pay off my credit card debt? - Kat in Charlottesville, Va.

A: I know this sounds like an easy solution, but you never want to borrow from your 401(k) if there's a chance you'll be leaving your job in the near future. It's not uncommon for a plan to require full repayment of the loan within 60 days of the termination of your employment. If you can't come up with the cash, it will be treated as an early withdrawal, which means you'll be taxed and penalized.

Right now your priority should be making that severance last as long as possible. So cut the fat in your spending. Go back to basic cable, double-check that you have the cell phone plan that meets, but doesn't exceed your needs, get rid of your landline and shop around for cheaper auto and homeowners insurance. Then concentrate on paying down the credit cards, putting any extra cash toward paying more than the minimums. And if you happen to land a job while that severance is still coming, you'll have even more money at your disposal to wipe away that debt completely.

Q: Is it still beneficial to put money in a 529 plan for my son's college education? -- Mason in Fort Worth, Texas

A: 529 plans are a great savings tool for college, whether we're in a good or bad economy. In the plan, your earnings grow tax-deferred and distributions are tax-free when used for qualified, post-secondary education costs like college. That said, saving for college is a lot like saving for retirement. If you start early in the game, you can invest more aggressively in the market because you have more time to weather the market's inevitable ups and downs. If you're getting close to sending your kid off to school, you want to take less risk because your money doesn't have enough time to bounce back from market lows. You are responsible for how your money is invested within the 529 plan, and a good plan will allow you both aggressive and conservative investment options.

Q: I am 70 years old and don't have nearly enough left for retirement. I get about $1,000 in Social Security a month, but my expenses are three times that amount. Would it be wise to get a reverse mortgage now and let the money grow until I need it, or should I use up what I have and then get the reverse mortgage? -- Virginia in Salt Lake City

A: I'd start by seeing if you can get your income more in line with your expenses. Can you cut back on any of your discretionary spending? Would you be willing to trade down to a less expensive home? Can you get a part-time job? (Because you're 70, you can earn money without hurting your Social Security benefits.) You might also invite a friend or relative to share your home with you and split the costs.

Once you've exhausted these options, you can carefully consider a reverse mortgage. "Reverse mortgages are for people who don't want to or can't sell their house and have no other source of support. They are expensive, and should be treated as a last resort," says John Rother, policy director for the AARP. If you decide to get one, your payout is calculated by factoring in age, the value of the home and the loan's interest rate. The older you are, and the more equity you have in the home, the more you'll be able to borrow. That means waiting is your best option, and in that time, home values will hopefully start to rebound, giving you more equity to work with.

Q: My husband and I bought three rentals during the real estate boom. Our plan was to keep two of the rentals for retirement and sell one for a little nest egg. However, the values have dropped 30 percent and now we can't sell any of them. They are paying the mortgage payments for themselves, but are starting to bury us with the taxes, insurance and maintenance costs. What would happen to our credit if we did a short sale with one to give ourselves some breathing room? -- Jessica in San Francisco, Calif.

The FICO score regards a short sale with the same degree of severity as a foreclosure -- in other words, not favorably. How big of a hit your score takes depends on a few things, including how high it was in the first place. If you have a good score -- say in the high 700s -- it could easily plummet by 100 or 200 points, says Craig Watts, the public affairs director at FICO. If you already have a low score, it will still drop, but not as far.

But it sounds to me like you're jumping the gun a little here. Under the terms of a short sale, you make a deal with your lender that allows you to sell the home -- or in this case, the rental property -- for less than the amount you owe. The lender gets the money from the sale, you get nothing, but you'll no longer be liable for the taxes, insurance and repairs. But short sales are an extreme option for people who can't make their mortgage payments, and can suitably prove this to the lender. Even then, the lender may not grant one.

Because you're able to make the payments on your loan, I'd expect that you're going to have trouble getting your lender to agree to this.

Keep your home on the market. I've talked to experts who think we may see a short recovery in the housing market over the next few months, and that could give you an opportunity to sell. In the meantime, if the property's value has dropped, you should file for a reappraisal to get your property taxes reduced. It's easy and inexpensive to do, either on your own or with a local attorney.