Unless you do a strict accounting of your income and expenses each month, it’s not easy to clearly determine whether you are living within your means and remaining solvent. And if you have a mortgage and unavoidable expenses such as child care, you may have a daunting monthly nut even if you are maintaining frugal spending habits. For busy people who are not accountants, and do not have the time or inclination to subject their finances to intense scrutiny, we have prepared a list of red flags that may indicate that you’re debt is not sufficiently under control. If some of them, or many of them, do apply to you, it may be time to pause and take a closer look at your spending habits. Here they are.
Let’s not be in denial about this one. Your credit cards should rarely even be used for credit. Their main purpose is to increase your credit score by enabling you to build a strong payment history that is reported to the major credit bureaus. Their secondary purpose is to gain you those points, rewards, cash back and other benefits that card issuers provide in competing for card holders.
While a financial emergency such as illness, major car repairs, or an exploding water heater may obligate you to pay on credit, that debt needs to be paid off as quickly as possible. The interest rates on credit cards, from the mid teens to over 20%, are simply too high, and you can end up paying multiples of the price of an item merely in interest on the purchase. Gather the strength to step away from that card.
Financial experts agree that the average household needs to have at least six months’ worth of their average income held as savings to protect against hard times, whether those hard times come in the form of illness, loss of employment, major auto or house repair expenses, or some other major expense that arises out of the blue. If you don’t have half a year’s income saved up, that is a red flag that expenses may be outpacing income, and that it may be time to tighten the belt.
Well, in this analogy you are both Peter and Paul. If you are juggling bill payments, selecting who shall be paid and who shall be asked to be patient, you’re already in trouble. While an emergency may thrust reasonable consumers into this situation, it should be rare, and once it happens, it is immediately time to dig yourself out.
This rule of thumb excludes mortgages, which may be classified as an investment. Generally speaking, if a fifth of your paycheck is going to the servicing of debt, you are likely testing the limits of what a household budget can endure.
There are other signs besides the ones listed above, and a quick run-through will probably be sufficient to alert you to whether you are in the leaky boat of excessive debt. Are you using your credit card to pay for necessities? Did you refinance a loan to reduce your monthly payment (not to take advantage of lower rates)? Do you need a co-signer on loans due to a low credit score? Are you financing your vehicle for a period of six years or longer? Has your request for a loan consolidation been turned down due to an excessive debt ratio? Do you have more than four credit cards? Are you paying your bills, but running out of money between paychecks?
If the answer to too many of these questions is “yes,” the red flags are flying, and it is time to pay attention to them.
The road out of excessive indebtedness is usually a long one, but it can also be an instructive one, leading to a lifetime of careful financial planning and activity. One important thing to do is to apply the First Rule of Holes, and stop digging yourself in deeper. Consider consolidating your credit card debt on a card that does not charge interest on balance transfers, and then pay off that debt before the promotional no-interest period ends. Beyond that, of course, you will need to cut expenses, and prepare to leave them lean for a substantial period of time.
Going for a leaner smart phone data plan, slicing those cable TV channels you rarely watch or even switching entirely from cable or satellite TV to streaming video will relieve a major strain on your budget. You’ll be surprised at how quickly you will stop missing items that you previously considered necessities. And if you are disciplined and patient, your finances will right themselves in time.