Debt Trap: Meaning & How to Avoid Falling in It
Piling up debt could bring unnecessary stress. Having multiple loan EMIs and credit card bills to clear and not repaying them could lead you into a debt trap. On the other hand, being completely debt-free could have a negative impact on your credit score.
The main question is – how to avoid falling into a debt trap. This article walks you through the best ways to avoid falling into debt by throwing light on the causes of debt. Read on to get all the smart tips you need.
What is a Debt Trap?
A debt trap means a situation in which you are trapped in a cycle of debt that has built over time.. For example, there are people who often apply for loans in succession to clear their preceding loan accounts. This is not a good practice at all and could have severe repercussions in your financial life.
If you desire financial freedom, you must be aware of the ways you can avoid a debt trap. Taking loans might seem to be a solution for your immediate financial inadequacies, but if you are not careful, they can cause irreparable damage
What Causes Debt Trap?
Let’s check out a few reasons that causes debt trap:
1. EMIs Exceed 50% of Your Income
Compulsive spending might strain your budget and end up creating a debt trap for you. If you become an impulsive buyer and fall prey to EMI schemes or discounts, you become more prone to falling into a debt trap.
If you start spending out of your budget and your EMI payments exceed 50% of your income, it can cause an alarming financial situation. Therefore, you must be mindful of your finances before buying out of impulse.
2. Fixed Expenses are More than Your Income
Nowadays, product marketing is making people want things they do not actually require. Additionally, there are a huge number of financial institutions ready to provide you loans with just the minimal documentation. This makes it easy for people to spend more than they earn.
If your fixed expenses are more than your income, this might be another reason behind a debt trap. Taking a number of loans at once might create such a situation.
3. Exhausting Credit Limit
Credit card debt is the easiest to get into. Most people get attracted by the exciting offers and get involved in never-ending credit card bills. On the other hand, credit card companies charge quite a lot of interest, which might range from 16 to 32% per annum. Many people use multiple credit cards and have a high credit card utilisation ratio but do not have the capacity to pay the credit card bills on time.
It is of utmost importance to keep a track of your expenses whenever you use a credit card. Repaying credit card bills after an interest-free period may lead to a high penalty. Therefore, it would be wise to use a credit card if you think you can repay it back on time.
4. Multiple Loans
If you are juggling multiple personal loans as well as credit card bills, you might be short on your living expenses. In such a situation, taking a single low interest personal loan and consolidating all your loans under one umbrella might be a great plan. It will ensure timely repayment of your loan and peace of mind. However, taking successive loans to pay your debts might not be such a wise choice.
5. No Repayment Plan
Credit cards and loans might look tempting; however, before opting for them, you must come up with a repayment strategy. Using an EMI calculator for calculating your estimated EMI before applying for a loan might help you plan your repayment strategy better.
Borrowing might be easy but repaying it can get tough if you do not have a repayment plan. You should borrow as much as you can repay and always remain prepared with a Plan B for the worst case scenario.
How to Avoid Falling into Debt Trap?
If you are already into a debt trap, coming out of it might seem impossible. However, it is not so, and there are certain steps that you can take to come out of your debt before you get trapped completely.
Here are some ideas that can help you escape from an impending debt trap:
- Check Your Priorities
Sometimes people tend to spend their money extravagantly without checking the expense heads and spending patterns. To avoid this, it is essential to create a priority list to segregate your needs. Categorise your needs into essential, semi-essential and non-essential. Try to focus only on the essential items.
By making a budget and tracking your monthly expenses, you can identify and prevent all wasteful expenses. This will help in minimising your discretionary and unwanted spendings and help to focus on the necessities. A disciplined approach will guide you to improve your spending habits and help in reducing the risk of falling into a debt trap.
- Build an Emergency Fund
One of the best ways to avoid a debt trap is having an emergency fund. An emergency fund consisting of your 6 months’ salary should be kept aside. With an emergency fund, you can sail across the stormy seas of financial uncertainties. It will help to run things smoothly momentarily and avoid a debt trap for a few months until the situation stabilises.
- Avoid Taking More Debts
You should not take any more debts to pay your previous ones. This is an important step towards avoiding a debt trap. If you keep taking loans to repay your previous loans, your monthly commitments will rise, which will only add to your mental and financial stress. This might be a bit hard to practice as avoiding borrowing means you might not be able to purchase certain things until you earn the money. However, you must stick to the rule of not going for impulsive purchases.
- Get Rid of High-interest Loans First
The debts that you have should be categorised as short term and long term. Short term debts might include personal loans and credit card loans, while long term loans include home loans. After this, you must focus on getting rid of the more expensive loans that have higher interest rates.
Home loans have lower interest rates while credit cards attract very high interests. Credit card companies charge monthly interest in case you fail to repay bills. Failure to repay them piles up interest and penalty charges. Therefore, prioritise paying back the loans in order of interest rate they attract and their payback period.
- Automate Your EMIs and Utilities Bill
You can authorise a bank or concerned organisation to automate your EMI and utility bill payment. As these bills are important and need to be paid on time without fail, having a system that automatically collects payment for these bills might solve the problem.
There are various options that you can choose from to pay utility bills automatically every month for necessities like electricity, rent, internet etc.
- Consider Debt Consolidation
Debt consolidation helps to settle many loans with just a single payment. This can simplify your life and help you come out of a debt trap. In this option, you consolidate all your loans under a single loan. If you use this, you will not have to worry about repaying multiple loans with different interest rates and different due dates.
Opting for a new personal loan with a lower interest rate in comparison with your old debts will help in reducing EMI outflow. Even if the repayment tenure goes up a bit, you can comfortably manage your cash flow and save yourself from debt traps.
Also Read: 6 Tips You Can Consider To Save Money In 2022
Final Word
Almost all of us had taken out loans when we needed money, and there’s nothing wrong with that. But managing funds poorly could be disastrous, leading to a debt trap. Tracking your income and expenses to determine how your money is being spent can help you avoid falling into a debt trap. Repaying loans and EMI’s on time would safeguard you from high-interest rates and help you meet your financial goals.
FAQs
Ans: Staying in debt isn’t wrong. However, piling up debts without having a proper financial plan can be disastrous. So, close your credit card or existing loans early only if you feel that your existing debts are causing financial stress.
Ans: If you have various loans with varying tenures, you can talk to your bank about consolidating these loans into one and reorganising the interest and tenure in a manner that is appropriate for your new situation. If you carry out these steps, you can reduce the interest rate. You can also try to negotiate with the bank to lengthen the term of the loan to cut down on the amount of the EMI payments.
Ans: If you’re sure of your repayment capacity then there’s nothing to worry about piling debt. It always depends on how smartly you can manage your money, repayments, etc.
Before you go…
Looking for instant 🚀 personal loans 24*7 anywhere, anytime? Get personal loans up to ₹20 lakh starting at 9.9% p.a. Install the Navi app now!
Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
Explore Personal Loan Offers in Your City
About the author
