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Everything about the Debt Trap

Everything about the Debt Trap

12 Aug 2019
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Borrowing is a convenient option for most of our financial needs. You can buy what you want without exhausting your current savings or finances. However, if you don’t manage your debts in a responsible manner, you may end up in a debt trap.

A debt trap is a financial situation in which borrowers find themselves trapped in a vicious cycle of re-borrowing where it is difficult to pay back the borrowed money.

Debt traps are usually caused due to high-interest rates or borrowing too much over a short period. Debt traps can have detrimental effects on your financial future. Here’s everything you need to know about debt traps and how to escape and avoid them:-

 

What is a Debt Trap and How it Works?

A debt has two basic elements; first is the principal amount and second is the interest charged on the principal amount. The principal refers to the total amount borrowed, while the interest is the amount of money that the lender charges on the principal. To get out of a debt, a borrower has to pay back both the principal and the interest. A debt trap occurs when the borrower is unable to pay back the principal and can only afford to make the interest payments. However, payment of interest does not lead to a reduction in the principal amount borrowed and hence the borrower never gets any closer to paying off the loan. The situation can be likened to a hamster on a wheel; running on the wheel but staying in the same place.

 

Signs That You Are Falling into a Debt Trap

  1. Dwindling credit score –Your credit score is the best indicator of your repayment capability. Keeping a healthy credit score requires timely repayment of debts. If you have a low credit score, identify areas where you may have a debt problem and try to work on them. For instance, you may have stretched yourself too thin on your monthly budget and have a skipped a payment deadline. In such a situation, you can consider requesting a waiver on your late payment of EMIs as it has happened for the first time and then keep repayment reminders and also save the respective amount for your loan EMIs from the monthly salary to avoid any late payment of EMIs. Regular payment of personal loan EMIs will also reenergize your credit score.

  1. Juggling multiple loans – If you are in a situation where you are juggling the repayment funds borrowed from your peers, multiple personal loans and credit card bills, your budget can get really tight. In such a situation, you can consolidate all your loans under one loan umbrella and get a single repayment window every month. This will ensure timely repayments and peace of mind.

  2. Lack of savings – If you haven’t started saving yet, don’t fret. It’s never too late to start saving. Saving money is essential to meet your future financial goals. You can consider investment avenues such as mutual funds, ULIPs, retirement plans and fixed deposits to start saving. By investing regularly in such schemes, you can benefit from the advantages of compound interest.

  3. EMIs exceeding 50% of income – Compulsive spending strains your budget and leads you to a debt trap when you regularly spend through EMI schemes or discounts which people often fall prey to. Hence, it’s important to be mindful of your finances before spending compulsively. If your EMI payments exceed 50% of your income, you are headed towards a debt trap.

  4. Loan for regular expenses – If you find yourself borrowing money to meet your regular expenses such as rent, kids school fees, grocery purchases, etc., you may be sliding into a debt trap. Such a situation should raise a big red flag, and you should focus on paying off your debts as soon as possible and avoid the temptation of further debt.

     

How to Get Out Of Debt Trap?

If you are already in a debt trap, getting out can seem like a daunting task. Once a borrower defaults on debt payments, it’s difficult to get cheaper loans to repay the existing debts, which further increases the debt burden. Although getting out of a debt trap is difficult, following these steps can help you escape debt traps:-

  1. Assess your finances – The first step to get out of a debt trap is understanding the extent of the debt. Take some time out to list down all your debts, along with their respective interest rates and outstanding loan amount. By doing so, you will be able to identify which loans are draining your pocket the most. Next, list down the must-have expenses such as your day-to-day household expenses, insurance premium etc. and calculate the total amount you can afford to repay on a monthly basis.

  2. Prioritize debt repayments according to interest rates – Unsecured loans like credit card dues have high-interest rates, which can increase your cost of borrowing exponentially. Hence, you should focus on paying off debts with high interest rates first and then switch to the low-interest ones.

  3. Seek help from family and friends – Many hesitate when it comes to asking for loans from friends and family. By borrowing from your friends and family, you can avoid paying high interest rates, which in turn will help you get out of a debt trap. However, this option may not work out at times.

  4. Liquidate your investments to pay off your debts – If you have made any investments such as fixed deposits or mutual funds, it is sensible to liquidate it and repay loans.

  5. Restructure your loan – Most lenders have provisions for restructuring a loan by extending the tenure. This will bring down the EMI so that the payment becomes manageable. However, the net interest payout will increase when you extend the tenure of a loan.

If all else fails, you can swap your high-cost debts with a comparatively low-cost personal loan. For instance, if you are stuck with paying off credit card dues at an interest rate of 40–45 per cent, you can pay it off by availing a personal loan. You can opt for Bajaj Finserv Personal Loans that provide tailor-made loan options to suit your debt needs. What’s more, by choosing Bajaj Finserv Personal loans, you get additional benefits like flexible repayments, Interest Only EMI in the initial stages and much more. To apply or know more about Bajaj Finserv Personal Loan, visit Finserv Markets.

Finserv Markets, from the house of Bajaj Finserv, is an exclusive online supermarket for all your personal and financial needs. Loans, Insurance, Investment, and exclusive EMI store, all under one roof- anytime, anywhere!