You Asked About Debt

I often try to answer leftover questions from my online discussions in this e-letter or in my print column, so today I'd like to explore two topics that I get a lot of questions about -- paying off debt and student loans.

Here's one question I received:

"I have an annuity worth $10,000 from a lawsuit many years ago. I currently have about $15,000 in student debt. I'm planning on attending graduate school in a few years and was wondering if I should use that annuity to pay off my student debt or keep it and use it for graduate school costs. I think the biggest issue is probably how either choice affects student aid: do they count student debt in your favor, and do they count an annuity against you?"

I asked Mark Kantrowitz to respond. He is the publisher of FindAid.org, which I think is one of the most useful Web sites on financial aid.

Here's what he had to say:

If the annuity is restricted by court order to pay for certain expenses (e.g., medical expenses arising from a traffic accident), it will be disregarded. If the annuity is part of a retirement fund, it will also be disregarded. Otherwise, it will be counted as an asset.

Since debt is not considered in the need analysis methodology (i.e., no benefit from having debt unless the debt is secured by an asset, like a margin loan secured by stocks, in which case the debt offsets the asset's value), using an asset to pay off debt will generally improve financial aid eligibility.

But the answer isn't quite that simple. It depends on the interest rate on the debt and whether the student has dependents other than a spouse.

For an independent student with no dependents other than a spouse, assets will be assessed at a rate of 20 percent. For an independent student with dependents other than a spouse, assets are assessed using a bracketed scale with a maximum rate of 3.29 percent. (All graduate students are by definition independent.) So the worst case impact of the annuity is either $2,000 (no dependents) or $329 (dependents other than a spouse). In the latter case, paying off the debt has minimal impact.

But we also need to look at the cost of the debt. If the student loans are high interest private student loans, the student should definitely use the annuity to pay off the debt. If the student loans are locked in at a really low rate (say, 2.88 percent), the student might be financially better off keeping the debt and using the annuity to help pay for graduate school, since the loans the student will get in graduate school will be at higher rates (6.8 percent for the Stafford and 8.5 percent for the Grad PLUS).

So if the student does not have dependents other than a spouse OR the student debt is not at a low interest rate, I'd recommend using the annuity to pay off the debt. If the student has dependents other than a spouse AND the debt is at a very low interest rate, I would NOT recommend prepaying the debt.

Good Vs. Bad Debt, The Debate Continues

Most of you already know that I'm a debt hater. I learned to despise debt from my grandmother, Big Mama. She used to tell me: "Debt limits your choices."

But in this world, debt is inevitable. In two recent columns, I questioned the uneven playing field consumers often find themselves when playing the credit card game. It's a game we rarely win, I might add. Even those of us who pay our credit card accounts off every month tend to spend more when using plastic.

Since my two columns appeared, many people weighed in with their own opinions.

Edward L. Yingling wrote a letter to the editor, "Debt Can Be Managed Wisely" (Mar. 12) about my Color of Money Book Club picks for March: "A Horror Movie for Our Times" (Mar. 4).

"As Ms. Singletary pointed out, the best debt is no debt," wrote Yingling, president and CEO of the American Bankers Association, a trade association for banks. "However, some form of debt is a reality for most Americans today, whether that debt is used to get a college education, buy a home or cover unexpected medical emergencies. When it's used wisely, debt can even prove to be a benefit."

Paige Sheen in Denver, Colo., like many other readers, believes that many people using credit fall into the credit trap by their own volition. "To me, the rules could not be simpler - do not spend more than you make. And if you can't control yourself, don't own a credit card."

"With poor Federal oversight and states kept out of the regulatory arena, companies are free to charge any fees they wish," wrote Sandra K. Anderson of Champlin, Minn. "Even lawyers don't understand the credit card agreements which all have binding arbitration prohibiting customers from seeking redress in court. Unless Congress acts, compelling Federal oversight already in place but inactive or allowing states to legislate and enforce within their borders, credit card companies will continue to keep their customers deeply in debt."

Jeff Bennett of Waldorf, Md., said the columns about credit cards sent him searching. "Fortunately, I have very good credit, but as your columns usually do, it caused me to look at my credit card account to be sure I knew what my interest rate was, what my billing cycle was, and how the interest is calculated. My credit card is fine in all three, but it was good to take a look to be sure I knew what was going on with my account. In addition, this led to a chat with my two college age kids."

Good for Bennett! I also suggest taking your kids to see a new documentary, Maxed Out, the documentary that coincides with my book club pick this month. Post film critic Ann Hornaday in her March 9 review notes the film's timeliness with the recent stock market plunge. For another review of the movie, read "Making a Statement About Debt" by Post staff writer Christina Talcott (Mar. 9).

Go see this film and then on March 29 at Noon ET, I'll host a live discussion with its director, James D. Scurlock.

Let's Chat Today

I'll be online today to answer your basic personal finance questions -- or jabs. Join me at Noon ET. If you can't make the chat live, submit your questions early, or read the transcript later.

Tax Time

If you haven't filed your tax return yet, you should take note of new rules about declaring donated charitable items. According to the IRS, to be deductible, clothing and household items donated to charity after Aug. 17, 2006, must be in good used condition or better. However, you can claim a deduction of more than $500 for any single item, regardless of its condition, if the donation includes a "qualified appraisal."

Even before the law changed, the IRS required reasonable estimation on the value of your donation as one taxpayer found out recently. Read The Post's Ylan Q. Mui report, "Unmerited Designs on a Tax Deduction" (Mar. 14) about how one New York woman unsuccessfully tried to claim a deduction of 49,000 for designer clothes -- very close to what she paid for the couture wardrobe.

For more information about charitable contributions read the IRS's Publication 526.

And don't miss Rob Pegoraro's Fast Forward column today about the ins and outs of tax software, the large Tax Time package that will be published in this Sunday's business section and our online resource guide.

You are welcome to e-mail comments and questions to singletarym@washpost.com Please include your name and hometown; your comments may be used in a future column or newsletter unless otherwise requested.