Debt is the total amount of money that someone owes to others. This includes a loan from a bank, borrowed money from family and friends, or any private lenders. Nobody likes to be in debt, but sometimes circumstances force you to borrow money from others and owe them.
When you opt for debt because of any medical emergency or purchasing a car or home, it is worthful in the end because you get ownership of that thing. But several other debts are not worthful and can be a trap for you. It is because of this debt trap that your finances will get worse.
The main reason why your debt becomes your debt trap is when your debt repayment is a never-ending process. It happens when loan repayment in EMI goes as interest, and there is no reduction of the principal amount.
There are several products and services available in the market that will give you temporary relief from debt. But in reality, they are debt traps that will make your financial condition worse. Have a look at these ten common debt traps and a few tips on how to avoid them:
- Credit cards: Even though they are helpful, but they must be used with caution. One of the best ways to avoid the use of credit cards is to know the terms and conditions by going through the agreement and paying bills on time.
- Overdraft protection programs: They are helpful but sometimes it may push you into more debt. In this case, it’s also better to go through the agreement and ensure you are repaying the overdraft amount to minimize all fees.
- Mortgage refinancing: It does not make sense for all. Make use of an online calculator for determining what makes sense for you.
- High-interest loans: Stay away from high-interest loans like payday loans, renting to own, car title loans, and tax refund loans.
- Emptying a savings account to pay off debt: Using a savings account to pay off high-interest debt, is a strategy that can backfire, and lead you into a debt trap. Avoid going into debt for every unexpected expense as it can be disheartening. Always keep adequate financial reserves to pay for emergency expenses.
- Difficulty learning financial basics: most people do not understand financial basics and find themselves trapped in debt. Unawareness of interest rates that are charged on loans or the total cost of buying something through a rent-to-own agreement can lead to a debt trap for many people.
Apart from proper handling of debt trap products and services, here are a few tips you need to keep in mind for avoiding the debt trap:
- Identify the problem: If you have more numbers of credit cards and have exceeded or are about to exceed the credit limit in one or more than one credit card, you will be in debt. One of the most significant risks is when you miss EMI payments and other charges in enormous quantities.
- When you can’t pay off your debts regularly and recognize that you can’t do it soon, it becomes a debt trap for you when the total amount of debt from several sources is more than your liquid assets, investment amount, and institutes significant portion of your salary.
- Prioritize your debt: Debts can be short-term or long-term. Credit cards and personal loans are short-term debt, and home loans are long-term debts. Give priority to the loan which is with high-interest rates, overhead costs, and fees after dividing debt by tenure. Long-term loans like home loans have a low rate of interest. Credit card loans have high-interest rates, which are as high as 35-40%. When you fail to pay the credit card bills timely, it incurs interest and other fees, increasing the overuse risk.
- Fill up the gaps and prepare a payment strategy: You can initiate by keeping a soundtrack of your expenditures when you face trouble saving money. Decrease your spending on some of the expenses on items that are not important such as leisurely trips, luxury procurements, movies, etc., try to create some of the imaginative ways for decreasing your daily costs like carpooling, taking a taxi to work, or consumption of homemade foods rather than ordering from outside.
- If time permits, you should consider taking some side jobs to supplement your income. Even though it’s a challenge, always keep in mind that it’s temporary, and you will not have to limit yourself till your finances are on track.
- Have ample insurance coverage: Buy suitable insurance for protecting yourself and your family from all types of shattering incidents. The more quickly you buy insurance, the lower your premium amount will be. Insurance helps you invest all of your money in paying off all debts rather than worrying about the increasing cost of healthcare.
- Extend your loan term: You can ask your bank to increase the loan terms when taking a home loan. While this will enhance your interest rate, it will decrease your EMI payments and offer you more time to pay off your debts.
- It would help if you also tried negotiating your interest rate with your bank when you have a long-term partnership with them. You can also try moving the existing loan to any bank with a low-interest rate in alternate ways.
- Debt consolidation: Rather than examining various loans with various interest rates, you must consider debt consolidation. This helps in simplifying your life and getting you out of the debt trap. It is one of the best ways to have a healthy financial status. Here all of your outstanding amounts get consolidated into one single payment in the form of a personal loan.
- Construct an emergency fund: Saving is always a healthy habit. Besides that, you must also create a special fund for managing emergency expenses. Like for instance, you met an accident, and you are out of work for several months, then you will require money to survive yourself.
- An emergency fund helps you to manage all of your expenses comfortably. With an emergency fund, you can easily navigate difficult times without falling back on a loan.
- Increase your payments and Emi contributions: If you want to pay your loans faster, you can increase your contribution towards EMI payments in proportion to the salary hike.
Conclusion
Debts are good until the purpose behind them is good. Every loan is not bad. An individual leading a disciplined life in terms of finances never gets into the trap of debt; instead, they end up making out the maximum from the loans they have burrowed. You must consider all things to avoid the debt trap.
