In a life ridden with financial liabilities, debts are the bane of one’s existence. However, with the current surge in cost inflation, sometimes debts are the only viable option. Whether it’s buying a home, attaining a degree, or borrowing money to tackle sudden health emergencies, debt is one such financial obligation that is deemed to be indispensable at the spur of the moment. A debt trap, as the name suggests, is a vicious loop where the borrower keeps taking more and more loans to pay off previous ones, and in the process, finds themselves in a situation where they have taken multiple personal loans and exhausted several credit lines, causing them to exceed their capacity to repay loans completely.
Let’s take a look at the common reasons that drive a person into a debt trap and all the ways that they can avoid falling into one!
#1 Lack of adequate financial knowledge
They say desperate times require desperate measures. In an urgent situation, opting for a quick personal loan seems to be the easiest solution. However, that’s probably one of the common reasons for getting into a debt trap as borrowers often don’t conduct market research before taking a loan. Taking a loan without assessing the EMIs offered by various lenders and calculating the ratio of these EMIs against your monthly take-home salary is what leads to debts. Moreover, due to this dearth of financial knowledge borrowers end up taking loans beyond their repayment capacity and get stuck in the quagmire of debt in the long run.
#2 Unsecured personal debt
Being a reckless spender with few assets yet multiple avenues of expenditure is always a sure-fire way of getting into a debt trap. Having multiple credit cards, and exceeding their limit with impulsive expenses and personal loans are a glaring indication that you are living far beyond your means. If your personal debts have a large amount of money to pay off, you will invariably struggle to make monthly repayments and this could cause you to borrow more money in a bid to pay off existing loans, leading you to get a bad credit score and an endless cycle of high-interest loans. Therefore, it helps to have fewer lines of unsecured debt.
#3 Financial losses
The lure of credit cards and personal loans may cause you to go overboard with your splurges, but it’s important to remember that financial institutions charge a decent amount of interest for the facility they offer, ranging between 16%-30% per year. Therefore, exceeding your credit card limit is one of the easy ways to fall into a debt trap. Other than that, taking multiple loans to manage the expenses of a small business or start-up could wreak havoc on your monthly repayment strategy, increasing your overall interest amount and EMIs.
The following are some expert-recommended hacks to correct a debt trap!
#1 Prioritize and save
At the very outset, you should prioritize your living expenses, chuck out irrelevant expenses, and decide on a budget plan that allows you to keep some funds aside to facilitate the monthly payment of EMIs. Saving up to 30% of monthly salary is recommended for people who may be on the verge of a debt trap situation. This ‘emergency fund’ will provide for those rainy days while lowering the chances of taking another loan to pay off existing debts.
#2 Debt consolidation
The easiest way to rectify a debt trap situation is to opt for a single debt consolidation loan that allows you to repay all your outstanding debts at a low-interest rate. When you do so, you combine all your debts into one, and merging them together paves the way for better payoffs, EMIs, and interest rates. This will also help manage unnecessary expenditures and set aside enough money for rainy days. However, it requires professional help of course.
#3 Pay off high-cost debts
If you’re fortunate enough to experience a deluge of cash inflow from a fixed asset or a passive income on a rental property on the side, or maybe stocks and shares sales, consider using the money to pay off debts that incur high balances, including credit cards and education loans. With these loans paid off, you can rest assured knowing that you have saved a decent amount of money that would have been funneled toward high-interest rates.
Most importantly, if you do have to end up taking a quick personal loan or a debt consolidation loan to pay off existing debts, consider educating yourself on the EMIs. In times of extreme crisis, you can always approach loan professionals who can provide financial advice on market-approved ways to repay loans. In certain situations, they can speak with your creditors as well to vouch for your integrity and allow sufficient time for repayment. In addition, they can assist with negotiating lower interest rates as well.
