Harm to credit standing lingers

Black marks remain after dealings with debt-settlement service

Dollars & Sense

July 14, 2002|By Liz Pulliam Weston | Liz Pulliam Weston,SPECIAL TO THE SUN

After I lost my job, I got talked into using a debt-settlement service, the kind that helps you pay off your bills for less than what you owe. The company assured me and my wife that our credit would recover quickly after all debts were paid off. I now know we were naive to believe them. But how long will it take our credit to recover from what we've done?

I'm now employed and have a good income, as does my wife. We own our home and have two credit cards, one with no balance and one for unplanned purchases that never has a balance greater than $500. Knowing how long our credit is going to suffer from this will help us do some planning for the future.

Two to four years of good credit behavior - on-time payments, no new accounts and light use of your credit cards - should help undo some of the damage, but the black marks will remain on your credit report for seven years.

It's too bad you didn't sign up with a nonprofit consumer credit counseling service rather than with a debt-settlement company. Credit counseling services set up a debt-repayment plan and negotiate lower interest rates with your creditors so that you can pay your debts back in full.

Debt settlement companies, by contrast, ask your creditors to accept less than what they're owed - that is, if they even stick around to fulfill their part of the deal. Some settlement companies simply disappear with the hefty $3,000 to $5,000 payment they typically demand upfront.

The difference to your credit rating is immense. Credit counseling in the vast majority of cases does not affect your three-digit credit score, which is used by many lenders to evaluate your creditworthiness. Your creditors might put a note in your credit report saying you're participating in a debt-repayment plan, but the leading credit scorer, Fair, Isaac & Co., ignores that information when computing your score.

Once you've completed the plan, your lenders remove the notation, and no one looking at your credit report would know that you were ever on a repayment plan.

With debt settlement, however, your creditors typically report that you've paid less than you owed. That stays on your record for seven years and lowers your credit score. What's more, that "forgiven" debt might be considered taxable income to you. So in addition to trashing your credit report, you also might have a hefty tax bill to pay.

It's probably not too late to contact the lenders who haven't yet settled and make arrangements to pay them in full. It won't undo the damage that has been done, but it could prevent matters from getting worse.

Several months ago you answered a question from someone who had quit his job to become a day trader, only to lose tens of thousands of dollars in the stock market. He wanted to offset these losses against his wife's income, but you told him he was limited to writing off $3,000 in capital losses each year, so it probably would take him years to use up all of his red ink. Why didn't you tell him about the mark-to-market election traders can make, which allows full-time traders to write off all their losses in a given year?

Two reasons. One, it was far too late for him to make this election. Two, once the election is made, any subsequent gains must be reported and taxed, even if the underlying investments haven't been sold.

The mark-to-market election allows true full-time stock traders to treat their holdings as if they had been sold at the end of the year, even if they weren't. Any paper gains or losses are treated as if they actually occurred. That means traders can write off the full value of any losses, but they must pay taxes on the full value of any gains.

This election must be made in advance, however - by the due date of the previous year's return, to be precise. The man who wrote in would have had to opt for mark-to-market treatment for his 2001 trading by the due date of his year 2000 return.

My wife and I are going to retire in a couple of years and we want to move to a place with no state income tax but keep our home in California for occasional visits. If we register to vote and buy a home to live in the other state, do we still have to pay California state taxes on our pensions because we have decided to keep our home here?

Tread very carefully in this area.

California no longer is able to tax the pensions of former residents who move out of state, something it used to do with relish. President Bill Clinton ended that practice. (Other states had been pursuing retirees too, but perhaps none as aggressively as the Golden State.)

Still, California tax authorities don't like to let money get away from them. If they can prove you're still a resident of the state, you'll get taxed. You'll want to spend the bulk of your time out of state, and you might need to take other steps to verify that you're no longer a resident.

For more information, chat with a good tax professional who stays current on residency issues.

You recently mentioned that people whose net worth was approaching $1 million should see an estate-planning attorney. You probably also should mention that people should include the face value of any life insurance policies. These amounts don't show up in net worth because they aren't technically assets or liabilities, but they can be a large part of the taxable estate of the surviving spouse. Because this easily can be addressed through proper estate planning (by using trusts, for example), these folks definitely should see an estate attorney too.

Good point. Hefty life insurance policies can be a godsend for your survivors but can wreak havoc with estate planning if not properly handled.

Liz Pulliam Weston is a columnist for the Los Angeles Times, a Tribune Publishing newspaper.

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