As credit cards balances get close to their maximum limits, your score will start to drop. In fact, a single credit card at its maximum limit can lower someone’s credit score by 75-100 points.  This drop in a score can be the difference between a mortgage loan approval or denial, or add 2% to the interest rate on a car loan.

Reducing the amount owed on a credit card is the fastest way to increase your score.  Even using 20% of the limit of a card ($2,000 with a limit of $10,000) can start to have an impact on your credit score.

Consolidating credit card balances onto one low interest rate card can save you money on credit card interest. However, if this also maxes out the limit on the low interest rate card, you will lower your credit score.  Save the money on the credit card interest only if you are not going to be using your credit score to qualify for something more important. That is, don’t try to save $50 on credit card interest and increase your mortgage payment by $300 due to a lower credit score.

How can you lower your balances and credit utilization ratios?

1. Don’t spend too much – imagine how things would look if Congress and the White House had to have the money to spend it?  You and I should know that, so we also need to live that way.  Credit cards are ok to use to get frequent flier miles, but if they are never not paid in full at the end of the cycle – they are a problem, not a solution. Quit spending more than you can pay each month!
2. Pay off your credit cards every time you get paid.  If you get paid bi-weekly, pay your credit cards online the day you get paid.  This way your balance is always low and manageable, and you never get tempted to carry over the balance from one month to the next.  The best savings accounts today yield only 0.25% to 1.5%, so don’t risk paying interest on credit cards in the hope that you will earn an extra $0.99 on your savings account while waiting to pay off your credit cards.
3. Call your established credit card accounts and ask them to increase your credit limits.  This won’t pay down the balance but it will reduce the amount owed ratio and help your score.  Many banks won’t do this anymore, but if you don’t ask, the answer is definitely ‘No’.  Ask.
4. Don’t do the balance transfers. Most people don’t read the fine print on the transfer and credit card lenders will stick you with a 3% balance transfer fee.  On a home loan, no one would pay 3 points to get a lower rate, but people do this routinely on credit card balance transfers. Balance transfers will usually leave you with a maxed out credit card and still cost you money.
5. Steamroll your credit cards.  Pick the card that is closest to its limit, and apply all extra cash to paying off that card.  When it gets to zero, take that cash and steamroll onto the next card.  Usually we use this strategy to get out of debt, but if the goal is to increase the credit score, rank order your cards in terms of how close you are to the limit rather than the actual interest rates. As each card is paid off, you will have more and more cash available to apply to the next account.  Pay off cards prior to other loans as loan accounts won’t impact your credit score as much as credit cards.

Keep Credit Card balances low.  Reducing what you owe on credit cards can increase your score by up to 80 points in as little as 30 days.

WARNING: This a graphic story of the financial destruction of an otherwise financially successful man.

Here’s a secret for you – your credit score will go down every time you do something that people did previously just prior to defaulting on their debts.  The credit scoring model is trying to predict the likelihood of you going 90 days or more late on an account.  If someone ever defaults on a debt, they leave clues well in advance of that default.

Here is the pattern of clues John left as he trashed his credit following a medical incident that left him out of work for a few months:

1. John needed some cash, so he applied for new credit.
2. Having a lot of equity in his house, John applied for a home equity line, but the application was denied since he wasn’t working.
3. With the financial pressure of medical bills and no income, John could no longer pay off his cards in full each month.  The amount owed starts to increase close to the limit on the cards.
4. Needing cash, he turned to alternative sources, getting a signature loan at a high interest rate.
5. He was late on a few credit card payments as the money just wasn’t there to make the payments on time and he was juggling the many open accounts.
6. Creditors turned over John’s accounts to collection agencies, who immediately notified the credit bureaus of the collections.  Collection agencies wanted to lower his credit score to prevent him from opening new accounts, leaving him with a greater chance of paying the collection agency off.
7. (Trying to sell his house didn’t help as the market was slow and declining, so his equity was disappearing).
8. John first went to a credit counseling firm and then eventually filed for bankruptcy.
9. Some debts were wiped out in the bankruptcy, and he just quit making payments on the remaining debts, feeling the situation was hopeless.
10. Creditors file suit and judgments get reported to his credit report.
11. Being unable to manage then debt load, he is late paying his taxes and a tax lien is filed in court against him.
12. Unable to even make his mortgage payment with the high costs of his other bills, the house is lost in foreclosure and all the equity in the house disappears in the soft real estate market.

John’s credit destruction was now complete after just a few tragic months.  The impact will last for years, as most of these items will impact his score and stay on his credit report for seven to ten years.

While this story is a myth, the events and results happen to good people every day.

Following the StartwiththeHouse.com strategy would have helped:

1. Always have an emergency fund – this would have tied John over during the short period when he wasn’t working.
2. Keep credit cards and other loan payments very low
3. Have proper insurance against all the threats out there – not just uninsured motorists, but illness, sickness, death or lawsuits as well.
4. Store your cash where is can be accessed.  In the above story, John had over $200,000 of equity in his house – but with no job, he couldn’t access it and lost his house in addition to destroying his credit.

Your mortgage can’t be just a loan to be hated – today it has to be an integral part of your overall financial plan to help you succeed financially.  Could you survive two months without work with the increased expenses of a health issue?  If not, what are you doing to make sure you have a different outcome?

Yesterday I published a list of things to do in 2010.  Today, I’m adding a few more comments to the remaining things to do.Here is a list of ten things you should consider doing in 2010 to get on better footing financially this year:

1. Build an Emergency Fund
2. Pay off any debts that aren’t increasing your wealth
3. Make sure you have the right insurances in place
4. Re-balance all your assets – make sure your money is where you want it to be
5. Review your mortgage
6. Buy an Investment Property or Help Someone buy their first home
7. Increase your 401k or IRA savings
8. Save for your kids College Education
9. Buy the home you really want (Prior to April 30th)
10. Buy your retirement home now, and then rent it until you need it.

4.  Re-balance all your assets:  For many Financial Advisors, they look at your stock, bond and mutual fund holdings annually or quarterly to re-balance everything.  Make sure you look at all your asset classes – including Equity in your house, and Cash Value in a life Insurance policy.  Read more about how quickly equity in your house can disappear and consider how much of your wealth you want to put in this asset class.

5. Review your mortgage.  Just like you would never buy a mutual fund and ignore it for 30 years, don’t expect your mortgage to be perfect for 30 years, either.  A mortgage checkup doesn’t mean you will refinance – it simply means that you will know if your current mortgage is the best loan for you.  This is more than just interest rates – it involves loan type, house equity, identity theft risk assessment, and minimizing your overall interest costs.

6. Buy an investment Property or Help someone else buy their first home.  With the low prices, tax credits, and low interest rates, an investment property may be a great way to diversify your assets, increase your net worth, and provide safe, affordable housing to your renter while they help you save on taxes, save more money, and increase your wealth.  If you don’t want to become a landlord, higher a rental management company to do it.

With the $8,000 first time home buyer tax credit, it’s a great time to help a family member with a gift of their down payment so they can buy their first house.

7.  Did you maximize your 401k or IRA contributions in 2009?  If not, increase your 401k with-holdings or set up an automatic IRA deposit plan to make that happen in 2010.  Many people don’t like that their 401k turned into a 201k in 2008, but it may be your only way to retire comfortably – don’t prepare yourself for the regrets of not doing what you can, even if 401ks / IRA’s aren’t perfect.

8.  Save for you kids college education.  In North Carolina, your 529 plan contributions can be free of state income taxes and anyone can contribute – give your kids’ relatives a chance to make a difference in your children’s lives by setting up a 529 plan and letting them know they can contribute.

9.  Buy the home you really want prior to April 30th.  If where you are isn’t where you want to be, when would be the best time to move?  Right now, actually.  With the low interest rates, $6500 home buyer tax credit, and low prices, this may be the perfect year to get into your dream home.

10.  Buy your retirement home now, then rent it until you need it.  Question:  Will Oceanfront property be cheaper or more expensive in 1, 20 or 30 years?  If you buy now, get a 30 year fixed mortgage, you will have more equity in the house from loan re-payment, and may even be able to have your retirement house paid for before you retire.  If you plan on renting the house in the interim, every trip to your retirement destination could be a tax deductible business trip while you are still working.

Here is a list of ten things you should consider doing in 2010 to get on better footing financially this year:

1. Build an Emergency Fund
2. Pay off any debts that aren’t increasing your wealth
3. Make sure you have the right insurances in place
4. Re-balance all your assets – make sure your money is where you want it to be
5. Review your mortgage
6. Buy an Investment Property or Help Someone buy their first home
7. Increase your 401k or IRA savings
8. Save for your kids College Education
9. Buy the home you really want (Prior to April 30th)
10. Buy your retirement home now, and then rent it until you need it.

1. Build an Emergency Fund.  Read more here and here.  Be ready to handle life surprises – an emergency fund is what you will use in 2010 if you don’t have 365 consecutive great days this year.

2.  Pay off debts that aren’t increasing your wealth.  A mortgage allows you to 1. own a house and 2. have you money somewhere else besides inside your house.  Credit Card interest, car loans, and student loans prevent you from saving money for the future.  When the interest expense is gone, your net income (money left at the end of the month) goes up – so you have more money to spend or save.

3.  Make sure you have the right insurance.  As part of the previously mentioned 365 consecutive great days, make sure you are covered if you get sick, hurt, or someone sues you. (Or if something really bad happens).  Review your insurance needs with an insurance professional – shoot me an email if you need a few good names of people you can call.

A recent Wall Street Journal story said, “More than 40% of borrowers who took out a mortgage in 2006 — when home prices peaked — are under water. Prices have dropped so much in some parts of the U.S. that some borrowers who took out loans more than five years ago owe more than their home’s value.”

After years of sounding like a voice in the wilderness, the numbers now prove what I’ve been saying: only money in the bank is like money in the bank. Home equity is not money in the bank.

The variable nature of home equity

Once you’re in a home, there are only three ways to extract money from it: sell, refinance or home equity line of credit.  Problem is,home equity can vaporize in each of the three.

Sell: You’ll lose between 6-10%of sales price on commissions and other costs — that’s given. But if you happen to try selling in a soft housing market, you could possibly lose on the sales price after a long time on the market.

Cash-out Refinance: Lenders only allow you to cash out 85% of the appraised value, leaving 15% in the house. And remember, this appraisal may come in for less than the prior one.

Home equity line of credit: The best-case scenario allows you to access 90% but a low appraisal or lender guidelines could make this option even less attractive.

This is not meant to discourage anyone from buying a home. On the contrary. Considering the tax advantages of home ownership and the quality of life that comes with owning the right home, most people should aspire to own a home of their own.

Eggs in one basket?

I advocate a balanced approach to placing long-term savings in  home equity along with other investment vehicles. A qualified financial advisor can help you diversify in an appropriate manner for your goals and circumstances. My caution to you is blindly following the advice that your first financial priority should be paying off the mortgage.

My friend Shane Tenny, Certified Financial Planner™ professional with NC-based Spaugh Dameron Tenny says, “It’s not only imprudent to have 50% of your investments in one company’s stock, it’s also just as risky to have 50% of your assets tied up in your house–an investment that’s not liquid, provides no return, and has no guarantees.”

The Financial Freedom Point

The key financial planning concept to master is the Financial Freedom Point: the time when you can use your investments to pay off the balance of your mortgage with the stoke of a pen. Until you reach the Financial Freedom Point, remind yourself of the risk that your home equity is just a number, not a reality.

Many people meet with a financial planning professional at this time of year, whether to map out end-of-year tax strategies or to chart a prudent course for the new year.

When you meet with your advisor, consider the role of the right mortgage in your overall strategy. This free guide might help you prepare for that conversation.

Click to Download Your Foundation for Financial Success (pdf)

I asked two local CPA firms, Toler, Bly & Associates, CPA, PLLC in Matthews, NC and James L Gibson, CPA, PC in Charlotte, NC to share with me some end of year tax planning tips.  I hope you can find some money saving ideas here:

Once December 31st has come and gone, your tax liability for the 2009 tax year will be set in stone. Until then, and especially now that your final tax picture for 2009 is becoming more clear, year-end tax planning presents a unique last chance to lower your tax bill. It is an investment in time well worth considering. By taking certain steps now, before 2009 draws to a close, you can reduce the size of your tax bill otherwise due when you file your return next year. Especially this year, when Congress has inserted a handful of powerful but temporary tax breaks to get the economy moving again, you do not want to overlook any deduction or credit that you can take in 2009.  Managing what income you recognize or defer also can pay dividends as you focus on balancing your tax rates between 2009 and 2010, and beyond, with tax reform on the horizon.

Year-end tax planning is made more urgent in 2009 because of some significant tax law changes, both those that have taken place to stimulate the economy and those now on the horizon to pay for the recovery.  Many of the tax breaks in recent stimulus tax bills will expire at the end of this year. At this point, Congress cannot be counted on to extend any of them for 2010:

• For individuals, these expiring provisions include the itemized state and local sales tax deduction; the $4,000 higher education tuition deduction; the additional standard deduction for real property taxes; and the above-the-line $250 teachers’ classroom expense deduction.
• For businesses, bonus depreciation and enhanced “section 179 expensing,” both designed to temporarily encourage business to make capital investments, likely will be headed for extinction at the end of 2009.

What’s on the horizon, for 2010 and beyond, is also crucial to effective year-end tax planning this year:

• In 2010, the opportunity to convert any IRA into a Roth IRA without the long-time $100,000 income restriction has many individuals already setting aside funds. Some individuals, however, may do better to convert to a Roth IRA before the end of 2009, when the value of their accounts, and the consequential income that must be recognized on conversion, are at historic lows.
• Effective for 2011, the Obama administration has proposed to increase the income and capital gains tax rates on single individuals with incomes of more than $200,000 and married couples with incomes exceeding $250,000. For taxpayers in those groups, including unincorporated small businesses from which their owners recognize income on their individual returns, following the traditional year-end planning maxim of deferring income into next year may not work well this year. Deferring too much income into 2010 could result in overloading income next year if you are looking to accelerate income into 2010 to escape the expected higher rates in 2011.

Planning for deductions and credits at year-end can also get complex but can be equally as rewarding. Timing and qualification rules create traps and opportunities:

• Pre-paying certain expenses, such as real estate taxes or mortgage interest, do not necessarily translate into a larger deduction this year.
• Paying a spring college tuition bill in late December instead of early January, however, can impact whether you maximize the benefit of the new American Opportunity Tax Credit for both 2009 and 2010.
• Year-end charitable giving generally has always been a smart way to reduce current year taxes but strict timing rules and revised substantiation requirements for property donations cannot be overlooked.
• Homeowners should also not ignore taking advantage of the new residential energy property credit, which has a unique set of rules on qualifying expenses and deadlines for installations.

Some things that you should be thinking about and some new laws that have been passed this year:

Making Work Pay credit.  Many wage earners are seeing an increase in their tax-home pay because of the Making Work Pay credit. Employers started using new withholding tables reflecting the credit in April. However, individuals with multiple jobs and some pension recipients may discover they had too little tax withheld when they file their 2009 returns in 2010. In May, the IRS issued a withholding option for pension plans to offset the Making Work Pay credit. The IRS also reminded individuals with more than one job to adjust their withholding. 

First-time homebuyer credit.  The first-time homebuyer credit reaches $8,000 for purchases between January 1, 2009 and June 30, 2010. (Home must be under contract by April 30^, 2010) Taxpayers must be qualified buyers and satisfy income requirements, and the credit can be up to 10% of the purchase price of the house, with an $8,000 limit.

Energy Credit.  A new law provides benefits to homeowners like you by reinstating the Credit for Nonbusiness Energy Property (CNEP) for 2009 and 2010. As you may know, the CNEP can be taken when qualified energy efficient improvements or expenditures are made for your principal residence, including new insulation; replacement windows, skylights and doors; central air conditioners; certain water heaters, furnaces or boilers; and a new metal or asphalt roof specifically treated to reduce heat loss. It increases the credit from 10 percent to 30 percent of qualified expenses and a maximum of $1,500.

Motor vehicle sales tax deduction.  The motor vehicle sales tax deduction is a temporary incentive created by the 2009 Recovery Act. The amount of the deduction is limited to the portion of the state sales or excise tax imposed on the first $49,500 of the purchase price of the vehicle.

COBRA premium assistance.  Individuals involuntarily terminated from employment between September 1, 2008, and December 31, 2009 may qualify for nine months of COBRA premium assistance under the 2009 Recovery Act. Some family members who are qualified beneficiaries may also be eligible for the subsidy. Individuals pay 35 percent of the COBRA premium and employers must treat that as full payment. Employers claim a credit for the other 65 percent of the premium on their payroll tax returns.

Roth IRAs.  Effective for 2010, individuals will be able to roll over funds to a Roth IRA regardless of current income. This could be a good way to get some pre-tax money deferred into post-tax accounts, especially with investment values as lower values than a couple years ago.

Unemployment benefits.  Individuals receiving unemployment benefits in 2009 can exclude the first $2,400 from their incomes. Individuals who are receiving unemployment compensation can elect to have income tax withheld on benefits. 

If you need a CPA to assist you with your taxes and tax planning, learn more about Toler, Bly & Associates at CPAResults.net or Jim Gibson’s services at www.JamesLGibson.com. Please let them know you learned about them here if you use their services.

Think you will get a big refund?  Create a plan now for the best use for that money. Build that emergency fund, pay off debt, or fund an IRA or college savings.