Don't be in a hurry to raid that IRA

Dollars & Sense

January 19, 2003|By Liz Pulliam Weston | Liz Pulliam Weston,SPECIAL TO THE SUN

My wife and I are both 50 and have no debt other than a home-equity loan with a $28,000 balance. Our home is worth $140,000, and we have $10,000 in savings. I would like to take $20,000 out of one of my individual retirement accounts and use that and our savings to pay off the home equity loan. I'm sure you're not a big fan of prematurely taking money out of retirement accounts, but the market just can't be trusted anymore. The way I see it, I'll be getting a better return by increasing my home equity.

The time when the market couldn't be trusted was when stock valuations were going through the roof. At least today a little sanity has returned.

But that's not the real issue. Regardless of what the market's doing, there are few situations where raiding a retirement fund makes sense -- and using the money to pay off a tax-deductible loan certainly isn't one of them.

Think about it. If you're a middle-income earner, you'll be paying at least $7,400 in income taxes and penalties to withdraw that money from your IRA, leaving you with just $12,600 to apply toward your loan. That's a 37 percent loss right off the top. Meanwhile, the debt you're paying off is probably costing you less than 5 percent annually after taxes.

There's no guarantee that home prices will keep going up, by the way, and even if they do, you actually would get a greater benefit by not paying off your loan. That's the beauty of leverage.

Here's why: Say you own a $100,000 home outright and its value increases 5 percent each year. At the end of five years, your home is worth nearly $128,000. Your equity has grown about 28 percent.

Your neighbor with the same type of house put only 20 percent down and took out a loan for the $80,000 balance. In the same five years, his home is also worth $128,000, but his equity has more than doubled -- from $20,000 to $48,000.

Then there's the issue of draining your savings, which is rarely a good idea. But if your debt was from high-interest, nondeductible credit cards, it could make sense to devote some of your emergency money to paying it off. Otherwise, you'd be smart to leave your liquid cash alone.

If you want to pay off the home equity loan, do it out of your current income, not your retirement kitty. And if you're worried about losses in your retirement funds, then reallocate the money you've got.

You probably got caught up in all the stock hype of the late 1990s and failed to adequately diversify. At your age, and given your risk tolerance (or lack thereof), you probably should have a stock allocation of 50 percent to 60 percent, with the rest of your money in bonds and cash. That might give you the comfort level you need to stop fretting -- and to keep yourself from making matters worse by pulling out of the market altogether.

My husband and I want to quickly improve our FICO credit scores so we can buy a home. His score is in the high 500s and mine is in the low 600s. We have two secured loans that will be paid off by then, and we are working on getting our credit-card debts down to about 20 percent of our available credit. How much should this improve our score? Is there anything else we can do?

Paying off debt is an excellent way to improve your credit scores, but unfortunately there's no way to predict in advance how much or how fast your numbers will rise.

The FICO credit scoring formula developed by Fair, Isaac & Co. is still a trade secret, although we know more about how it's calculated than we did a few years ago.

That's why consumers interested in improving their scores are no longer told to close credit-card or other accounts. Such a move, once thought to improve FICO scores, can never help a score and might hurt it, Fair Isaac says.

The most powerful way to improve your score is simply to pay your bills on time, all of the time. If you have any old, unpaid debts on your credit report, you could benefit from paying those off as well. Don't apply for any new credit until after you've got your home loan. And get copies of your credit reports, so you can make sure your score isn't being hurt by erroneous or out-of-date information.

Liz Pulliam Weston is a contributor to The Los Angeles Times, a Tribune Publishing newspaper.

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