Late Payments Never Help Credit Scores But They Don’t Always Hurt
Question: For the last 10 years I’ve been self-employed as a freelance editor and writer. Though a freelancer’s income is a roller coaster, I’ve maintained a good record of timely payments on my only two sizable debts: my student loan and my mortgage.
The last two months, however, have been rough, with the result that my February, March and possibly April mortgage payments each arrived at the lender’s office one day late. Friends are now telling me that the two (possibly three) consecutive late payments have effectively ruined my good credit standing. Can a 40-year record of meeting financial obligations be wiped out by three late mortgage payments?
Answer: Not quite--but that’s no reason to get sloppy.
The good news: It’s quite possible your lender hasn’t reported your late payments to the credit bureaus--the companies that compile your credit history. Many mortgage lenders don’t report late payments until they’re 30 days or more past due.
The bad news: If your lender did report your late payments, your tardiness could indeed put a significant ding in your credit history. Lenders get nervous when people start making late payments, and that’s reflected in the way credit scores--those widely used, three-digit numbers that reflect your credit worthiness--are computed. Your payment history makes up about 35% of that score.
Your previous history of on-time payments would somewhat ameliorate the damage, but only somewhat. What would help even more is getting your act together: The importance of any late payments will fade over time if you return to your previous prompt habits.
This is one more reason it’s important to have cash equal to several months’ worth of expenses set aside in an emergency fund. Such a cushion can save you from having a scarlet “L” (for “late payments”) sewn to your reputation.
Index Funds Can Lower Capital Gains
Question: I have had the unfortunate experience of owning several mutual funds that declined in value during the last year and for which I had to pay thousands of dollars in income tax on capital gains distributions and dividends. Is there any way to avoid this?
Answer: You could consider investing in index mutual funds. These funds replicate standard market benchmarks such as the Standard & Poor’s 500. As such, they don’t buy and sell stocks nearly as often as actively managed mutual funds--and less trading means lower capital gains distributions.
You also can look for so-called tax-efficient or tax-managed mutual funds, which strive to offset any gains with losses to reduce the capital gains distributions to investors.
Of course, you may face other tax consequences if you sell what you have now to get into index funds. Any gains you have in the funds you sell would be subject to capital gains taxes. If you’re shaky on how all this works, consider talking with someone who knows your tax and investing situation--a savvy accountant or financial planner--before you make your next move.
Death Benefit May Be What Matters to Some
Question: If you can stand it, here’s one more perspective on the annuities-in-IRAs debate. You mentioned that annuities have higher costs than mutual funds, in part because annuities have a death benefit.
That benefit ensures that the investors’ heirs will get at least the amount of money that was originally invested, even if the value of the account has dropped when the investor dies. You cited research that shows insurers may be charging five to 10 times what this death benefit is worth. But if the annuities’ total cost is only about one percentage point more than similar mutual funds, isn’t the death benefit alone worth the cost, even if the insurers are making a profit?
Answer: The cost of that one- percentage-point difference can mount pretty quickly. That’s why you hear former Vanguard Group Chairman John Bogle railing about fees and investment costs: Seemingly small percentages can have an outsize effect on how much money investors ultimately see.
Say you opened two IRAs, one invested in a mutual fund that costs about 1% a year and the other invested in an annuity that costs about 2% a year. Both IRAs are invested in a similar mix of stocks and other investments that return an average of 10% a year for 30 years.
If you started with $100,000 in your mutual fund IRA, you’d have about $1.5 million after 30 years. A similar investment in your annuity IRA would net about $1.1 million. The difference--nearly $400,000--is the cost of that extra 1%.
For some people, the security of having that death benefit is well worth the cost. For others--particularly those who care more about having money in retirement than in leaving it to their heirs--the cost may be more than they want to pay.
If you want to know more about annuities, check out the information at https://www.latimes.com/insure101. The Securities and Exchange Commission has a helpful pamphlet on variable annuities at https://www.sec.gov/investor /pubs/varannty.htm.
Send questions to Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail moneytalk@latimes.com.
