Financial Crisis HelpLine, Part 3

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November 18, 2008

QUESTION: Over the past 11 months, my 401(k)'s value has been cut in half. With the way the market is today, does it make sense to withdraw my 401(k) funds and pay off the $62,000 I still owe on my home, as well as other outstanding bills? Once we've paid off our debts, I'd start investing in the 401(k) again.

—Al Gaskins

ANSWER: Withdrawing money from your 401(k) can prove to be a big mistake. Not only will you get hit with a 10% penalty, but you'll also have to pay taxes on that amount. Say you're in the 25% tax bracket and you decide to withdraw $62,000 to cover the remainder of your mortgage. By the time the penalty and taxes are paid, you'll only have some $41,000 left — nowhere near the amount you owe on the house, says Kim Snider, CEO of Dallas-based Snider Advisors, an SEC-registered investment advisory firm.

And while it's scary to watch the Dow lose hundreds of points in a day and your 401(k) balance get decimated, there is an upside: By continuing to contribute money into that account, you're now buying shares at much cheaper valuations. This is known as dollar-cost averaging and it can prove very beneficial in beaten-down markets. Once the market rebounds you will have more shares in your account to take advantage of those gains. Pull out now and you'll lose out on them, says Snider.

One last thing: While most people like the idea of living a debt-free life, paying off the mortgage may not be the best choice. For the most part, mortgages are considered "good debt" since they tend to carry lower interest rates than say, credit cards or auto loans. It's best to concentrate on those higher-interest obligations first.

QUESTION: I need to rebalance and increase my exposure to bonds/Treasurys. Some bond funds have done well this year. Is it too late to invest in these funds?

—Jim Stafford

ANSWER: Investing in bonds can be tricky. Are you interested in government or corporate? High yield or investment grade? Taxable or tax free? The list goes on. That said, it's wise — and never too late — to rebalance a portfolio. Assuming you have straightforward savings goals and are buying to hold, low-cost and diversified bond funds offer a practical counterweight to stock holdings. One of the best mutual funds of its kind is Vanguard Short-Term Bond (VBISX), up 3% year to date. (Compare that to the 40% plunge in the S&P 500 index.) It's dirt cheap, best in its class over the past decade, and holds a mix of high-quality Treasury, corporate and government agency debt.

If you're confident enough to try your hand at individual bonds, a good place to start is TreasuryDirect, a government-run web site that allows individual investors to purchase Treasury bonds, Treasury Inflation-Protected Securities (TIPS) and savings bonds. Prices for all manner of bonds, from munis to corporates, can be researched at the web site of FINRA, a nongovernmental securities regulator. In most cases you'll need to contact a broker to purchase individual bonds trading on the secondary market. While not for the faint of heart, columnist James B. Stewart recently made the case for investing in the bonds of Goldman Sachs (GS), which are yielding 8% or more, a reflection of the added risk that they carry.

November 17, 2008

QUESTION: My husband was transferred for work, and we're having a difficult time selling our old home. We've tried everything — from reducing the sale price to offering it for rent. We qualified to hold both mortgages, but realize that our home may take months or years to sell/rent and the money for the old home payments will eventually run out. What are the most serious ramifications of foreclosure? And if we end up in foreclosure, will it impact our ability to get college financial aid for our kids when they go off to school?

—Anonymous

ANSWER: If you can, try to avoid going into foreclosure. On average, a person who forecloses on their home will see their credit score drop by 300 points, says Danielle Babb, a real estate analyst. And that black mark won't be wiped off their credit record for seven years, she says.

Also, going into foreclosure will make it very difficult for you to take out any new loans, say, for a car or a home equity line of credit or home equity loan. In most cases, lenders will deny you outright and the offers you do get will almost certainly come with high interest rates and fees. Credit-card issuers, too, will jack up your interest rates, or worse, discontinue your account.

Foreclosure also makes parents ineligible for the Plus loan — a loan that can cover a year's worth of college costs. Undergraduate freshmen and sophomores whose parents are denied a Plus loan for any reason (including foreclosure) do become eligible for $4,000 more per year in unsubsidized Stafford loans, however. (Juniors and seniors can get $5,000 more per year.) But that's little consolation, especially considering that private student loan lenders will almost certainly turn you down as well. The only way a student will get approved for a private loan is if they can offer a creditworthy adult as a co-signer.

QUESTION: I own more than 8,000 shares of Wachovia (WB) common stock. What will happen to it when the merger with Wells Fargo (WFC) takes place? Will the dividend continue?

—Mariane Schaum

ANSWER: This merger's been a pretty brutal one, and it's not quite finished. It took a while for Wells Fargo and Citigroup to settle which of them would acquire the battered Wachovia, and Wells Fargo finally won the day early last month. Under the merger agreement, Wachovia shareholders will get 0.1991 Wells Fargo shares – about a fifth of one share — once the merger is approved by stockholders. That vote hasn't been scheduled yet, but a Wachovia investor relations representative says it will happen before the end of the year.

That means 8,000 Wachovia shares become 1,592.8 Wells Fargo shares, which isn't a great payoff for current shareholders. When weighed against Wachovia's huge losses and 87% drop in its stock price over the past year, it's still better than nothing.

The Wachovia dividend, now at five cents a quarter, will become Well Fargo's dividend, now at 34 cents. Morningstar analyst Jaime Peters calculates the future dividend at 27 cents a quarter on a pro-forma basis, once the dilutive effect of the Wachovia shares is factored in. That means the $400 quarterly payout for 8,000 Wachovia shares becomes about a $430 payout for freshly minted Wells Fargo shareholders. A special dividend, sometimes paid before a merger takes effect, isn't likely.

"You're actually a little better off," she says. "I hadn't thought of it that way yet, but it's true."

One thing investors should bear in mind is that Well Fargo has lined up with other banks to get federal bailout funds, a move most participating financial institutions felt they had to make. Peters reminds shareholders that by taking federal funds, Wells Fargo can't boost its dividend without government approval.

November 13, 2008

QUESTION: I have a variable rate mortgage that is due to reset at a fixed rate in April 2009. Currently, the mortgage is worth more than the property and I'm concerned that the fixed rate will result in substantially higher monthly payments.

—Anonymous

ANSWER: Unfortunately, there may be nothing you can do to avoid the switch to the fixed rate. You could try to refinance the loan. But, due to the credit crunch, banks aren't as willing to refinance — especially to homeowners who don't have any equity in their property.

Another possible solution is to ask the lender for a loan modification, which could lower the interest rate and principal and bring the monthly payments down. Banks, however, typically reserve modifications for consumers who've experienced a hardship, such as a temporary job loss or medical problem, and are already delinquent on payments, says Justin Pane, vice president of Amerimod Modification Agency, a Uniondale, N.Y., company that specializes in loan modifications. And, in some cases, lenders will rework the terms on a loan if the homeowner is at risk of falling into delinquency. Banks will not, however, modify a mortgage simply because a consumer doesn't want to make a higher monthly payment, even if the property has fallen in value, Pane says.

For more on mortgage solutions, read our story.

QUESTION: I own preferred stocks in Morgan Stanley (MS), Bank of America (BAC) and a few other companies. Do my preferreds come in line ahead of the preferred shares the federal government will receive from these companies in exchange for bailout funds?

—Walt Carter

ANSWER: This probably isn't the answer you were hoping for, but no. Under the terms of the Troubled Asset Relief Program (TARP), your preferred shares come in line after those held by the federal government.

But that doesn't necessarily make preferred shares, which function more like a bond than common stock because they pay fixed dividends, a bad investment. In the event something catastrophic happens to a company, preferred stockholders generally get paid off ahead of common stockholders, though there's no guarantee remaining assets will be enough to make anyone whole. But then again that's why preferreds pay higher fixed dividends: You're being compensated for the risk.