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Installment loan can help rebuild credit scores

Would a car loan be a smart choice? Also: Do research before moving to a less costly part of the country just to save money, and don't try to duck payroll tax.

August 07, 2011|Liz Weston | Money Talk

Dear Liz: I am working on paying my bad debt from the past to rebuild my scores. I have one credit card that I pay in full every month, but no installment loan. I recently was given the opportunity to take a car loan with monthly payments I could easily afford. Here is my confusion: Taking on more debt while trying to eliminate past debt is usually not advisable. But I also know creditors like to see both revolving and installment credit. Am I OK to take the car loan to improve my mix of credit, or should I just use that extra money to pay off my past debt?

Answer: Adding an installment loan such as an auto loan, mortgage or student loan to your credit mix can indeed help rehabilitate troubled scores. But it's advisable only if you're well on your way to having the rest of your debt paid off. Otherwise, you risk stalling on your debt repayment or — worst-case scenario — adding another bad debt to the pile.

If your scores are still troubled, the car loan probably has sky-high interest rates. If you go this route, put down at least 20% of the purchase price so that you can refinance to more favorable terms in a year or two when your scores improve.

A better option may be to skip the car loan and try to get a three-year personal loan from your credit union. This fixed-rate loan would allow you to pay off some of your other debt while improving your scores.

Once your debt is paid off, you can save up to either buy your next car with cash or at least make a substantial down payment so you have to finance only a portion of the purchase.

Finally, you should know that although using and paying off your credit card is definitely helping your scores, paying off old debts may not be so helpful to your numbers. If the bills are already in collections, you may not see dramatic improvements in your scores as you retire those debts. That's why you would be smart to look for other means to improve your scores.

Research before relocating

Dear Liz: I'm 55 and single with no dependents. I have about $250,000 invested. I rent an apartment in Los Angeles. I work in sales, which I can do anywhere. Would I be better off buying a house for about $150,000 now (somewhere in the middle of the country), thus reducing my living expenses (property tax and insurance will cost much less than rent) and leaving me with about $100,000 left for retirement, or just continuing to invest the entire $250,000 for retirement?

Answer: Moving to a less costly part of the country is a time-honored way to make your money stretch further in retirement. It also can help you save more for retirement if you dramatically lower your living expenses.

What you don't want to do, though, is incur all the expenses of moving and buying a new home only to discover you hate where you're living. Do substantial research and visit your targeted communities at different times of year before you commit.

Also, tying up 60% of your portfolio in a single, illiquid asset such as a home is risky. You may well be better off moving to a cheaper area and continuing to rent until you've built up a bigger nest egg.

Don't try to duck payroll tax

Dear Liz: I am 66 and receive Social Security benefits in addition to working part time. I'm covered by Medicare. My employer deducts payroll taxes for Social Security and Medicare from my paycheck. Since I get no benefit from these taxes, do I have any recourse to recovering what amounts to $100 a month? My employer says the payroll service it subscribes to automatically makes these deductions.

Answer: The short answer is no. If you work, you typically have to pay into the Medicare and Social Security systems. Console yourself with the fact that you're at least receiving the benefits for which you paid earlier. Younger workers typically pay in much more each month with no assurance they'll get the full benefits they've been promised. As currently structured, Social Security will be able to pay just 75% of promised benefits after 2036, and Medicare is scheduled to run into the red several years earlier.

Liz Weston is the author of "The 10 Commandments of Money: Survive and Thrive in the New Economy." Questions for possible inclusion in her column may be sent to 3940 Laurel Canyon, No. 238, Studio City, CA 91604 or via Distributed by No More Red Inc.

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