Short Sale Of Home Hurts Credit Scores

Dear Liz: I sold my house for less than what I owed on the mortgage, not realizing that this short sale would affect my credit scores. Because of this drop in scores, I recently received a letter from my credit card company closing one of my unused accounts. I have two other cards with the same company, one of which I actively use. The other I haven't used for two years. Is there a chance the credit card issuer will close these accounts as well? I have two more inactive accounts with other issuers. Is there again a chance that these will be closed too? What can I do?

Answer: Any time you don't pay a creditor in full, you risk damage to your credit scores. As I mentioned in a recent column, the leading FICO credit scoring formula doesn't have a specific code to denote a short sale, but lenders may use codes that indicate a settlement for less than what's owed – and that's considered a serious black mark against your credit.

If your scores plunge, your credit card issuers may react by raising your interest rates, lowering your available credit or closing your accounts entirely. Having your limits lowered or your accounts closed can further damage your scores.

Your issuer may be less likely to close your accounts if you keep them active, but there are no guarantees. If you do use the cards, don't carry balances and don't charge more than about 30 percent of your credit limits. (Using 30 percent or less of your credit limits can help improve your scores, and not carrying balances is simply smart money management.)

To rehabilitate your scores, continue using your cards frequently but sparingly. Pay your bills on time, and consider getting an installment loan, such as a personal loan or an auto loan. The interest rate you'll pay will be high, so try to get the shortest possible loan and pay it off as quickly as possible. Having both types of credit -- revolving lines such as credit cards and installment loans – and using them responsibly can help restore your scores over time.

Dear Liz: I'm in my early 20s and looking for some advice on how to grow my money. My monthly expenses are relatively low, about $700 a month, and my take-home pay is around $1,300 a month. I'm looking for the best way to invest that $600 a month, as I want to start securing my financial future early (even though I'm not paid much). What would be the best option for me? I've been immersing myself in learning about the stock market and looking into mutual funds and bonds as another way to grow my money.

Answer: Good for you for getting an early start. Someone who starts saving for retirement at 22 can wind up with 30 percent more at 65 than someone who delays just five years.

If you have a 401(k) at work, take advantage of it. Contribute at least enough to get the full company match, if one is offered.

If your employer limits how much you can contribute or doesn't offer a 401(k), open an individual retirement account or a Roth IRA. You can contribute up to $5,000 a year to an IRA or a Roth IRA.

You can use the rest of your available cash to build up an emergency fund, or if you already have at least three months' expenses set aside in such a fund, you can open a taxable brokerage account to save more for retirement.

Because you make less than $26,000, you can also qualify for a tax credit of up to $1,000 for contributing to retirement accounts. See IRS Form 8880 for more details.

The easiest way to invest your money is by using so-called life-cycle or target date maturity funds. These mutual funds do most of the work for you: They set the asset allocations of stocks, bonds and cash, rebalancing frequently so that you don't wind up taking too much or too little risk. Most 401(k)s, mutual fund companies and brokerages offer these options.

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© 2008, No More Red Inc. Liz Pulliam Weston is author of “Easy Money: How to Simplify Your Finances and Get What You Want Out of Life.” She regrets that she cannot respond personally to inquiries, but questions for possible inclusion in her column may be sent to 3940 Laurel Canyon Blvd., #238, Studio City, CA 91604, or use the “Contact Liz” form at her website, www.lizweston.com.

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