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5 Red Flags That Show You’re in Financial Trouble

Brian O'Connell

While economies can collapse seemingly without warning, a personal debt crisis doesn’t happen overnight.

Most of the time any foreclosure or a personal bankruptcy is years in the making. Unfortunately though, along the way people often don’t see the warning signs that could stop – or at least slow down – the problem before it hits critical mass.

According to the Federal Reserve Bank of New York, as of the fourth quarter of 2010 approximately 2.8 million U.S. homes have gone through foreclosure, and another 2 million homes are in the process. Bankruptcy numbers aren’t much better, either, even if they are trending in the right direction. The American Bankruptcy Institute reports that the total number of U.S. bankruptcies filed from September 2010 to September 2011 reached 1.47 million, down from 1.60 million in the previous year.

How can you avoid become a statistic in either group? With a built-in “radar” system that warns you when your financial picture is starting to spin out of control. Here are five “red flags” that you can use to build that warning system:

You keep overdrawing your checking account. A bank checking account is like the proverbial canary in the coal mine when it comes to your personal financial picture. If you’re constantly overdrawing it – even once a month is a serious sign if it happens repeatedly – you need to get your financial act together. You’re likely spending too much money and possibly accumulating too much debt, or your income simply does not meet your expenses, in which case there are other forms of assistance to consider. Fix the problem by building a monthly budget and sticking to it.

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Your credit card payments are dwindling. If you can only afford to make the minimum payments on your monthly credit card bill (if that), you’ve got a borrowing problem. Credit card users keep paying interest on that big outstanding balance, and within a few months a $5,000 credit card tab can climb to $7,500. The solution? Use your card less (ideally, only for emergencies) and pay at least twice your minimum card payment. That should keep you out of credit card trouble.

Your emergency fund reads “zero.” If you don’t have an emergency fund, or the one you have is on life support, you’re courting big financial trouble. Experts historically say you should have at least six months’ worth of income stashed away in a savings fund, but it’s better to aim even higher. Build a 12-month cushion in case you lose your job or suffer from a major illness or injury. Most bankruptcies occur after a job loss or a serious health issue, so a proper emergency fund can save the day in that regard.

You have to choose which bills to pay. If two bills come in the mail and you can’t afford to pay both, you’re overstretched financially. If this happens once, no worries – it’s a tough economy and most people have problems with a bill at one time or another. But if it’s a monthly occurrence then you’re in “red flag” territory and need to revisit that budget and see where you can cut some meat off the bone (or take a second job to earn more income).

Your credit score is below 620. If your FICO score is heading south faster than a Canadian goose in December, that’s obviously a big red flag. The lower your score, the more expensive it becomes for you to get credit (creditors charge higher interest to give credit to consumers with low credit scores – if they grant them a loan at all). Read your credit report at least twice a year and directly address any problems right away.

If you find that you meet at least two of these red flags, you could be heading toward financial peril. But if you pay attention to the warning signs you could help to avoid or reduce the impact of a potential financial Armageddon.