What is debt trap and how to escape it?
Created on 06 Apr 2022
Wraps up in 6 Min
Read by 2.2k people
Updated on 27 Aug 2022
Ah! This is a painful subject to talk about, for those who have suffered through this, know of its real expense on one’s financial resources.
The day that my first credit card arrived at my doorstep, I was ecstatic. The limit was ₹1,00,000, and my monthly expenses would be covered in a fraction of this amount. I had A LOT of money to finally buy things I never could and so I went on a shopping spree. I just kept paying the minimum amount due (MAD).
This continued for a few months, and the interest kept accruing. I did not pay much heed to that, and little did I know how much would the amount add up to after interests.
After approximately six months, I was deep in debt.
Except that I was not, and this was completely hypothetical. But, this is a true story for approximately 50% of the credit card holding population.
The cycle of the debt trap feeds on itself and keeps growing bigger and bigger if the concerned person does not actively do anything about it. Let us educate ourselves today on this financial trap,, and how does one come out of it?
What is Debt Trap?
It is a very absurd analogy to compare with, but the debt trap is a lot like love. You wouldn’t realize you are falling into it, and when you do, you are knee-deep into it. You could try your best to escape it, but it becomes very difficult and painful to come out of it (😈).
A debt trap is a condition of getting stuck in a cycle where you are burdened by debt that accumulated over time with high interest getting added to it. You might be forced to take another loan to repay the previous loan where you pay interest on both the loans, adding to the sum.
Over time, this spirals out of control and exceeds so much that your repayment capacity falls short, and you get stuck in a cycle.
How does debt trap work?
A debt trap is a situation where you’re forced to take fresh loans to repay your existing debt obligations. Such a situation arises when your debt obligations exceed your repayment capacity. Basically, aamdani atthanni kharcha rupaiya.
Let’s take the example of Sharma ji. Sharma ji’s daughter wanted a lavish wedding that was way out of his pocket and league. But she was adamant and wouldn’t hear an excuse. Sharma ji then had to take a personal loan with an interest rate of 13%. But since Sharma ji was retired, his pension would not cover the family’s expenses and the loan EMI. Soon he started to skip EMIs. More interest accrued on the unpaid EMIs and his debt obligation kept on increasing.
But Sharma ji was a smart man. He noticed the accrued interest and took a loan from his loaded cousin. His cousin agreed to loan him an amount but with an interest of 11%. So now, he was paying interests on two different sums and that too for years. Not so smart after all, huh?
What causes debt trap?
These are the major causes that could lead one to debt trap-cy:
When your EMIs exceed 50% of your income
The marketing of products has reached new heights. This has caused people to impulsively shop or shop out of the compulsion to own everything trendy. This triggers unnecessary expenses, and these expenses are out of budget for one. People naturally lean and rely on credit to meet these expenses. This increases the EMI load, since the EMI of house, car etc. are already ongoing.
When your fixed expenses are more than 70% of your income
There are some fixed expenses every month that you just cannot escape, like rent, fuel, school fees, utility bills, etc. The ideal fixed obligations to income ratio should not be more than 50%.
You have way too much debt/loans
The home, car, laptop etc. EMIs that you pay, add up to a lot. More loans mean more interest to pay. More interest to pay ultimately leads to a lot of financial burdens, which become difficult to manage along with fixed expenses.
When you are in credit card debt
Credit card debts are the worst. The finance rates of credit cards are higher than personal loans and once you start defaulting in payment of the bills, you get stuck in the cycle of paying interest on interest and boy, this is such a vicious cycle.
When you can not set aside money for savings or investments
Saving and investing money is the straightforward no rocket science wala tarika to grow money. If your complete revenue is going into expenses and EMIs and nothing is left for you to save and invest, it is bad news.
How to come out of a debt trap?
Here is what you could do if you ever find yourself in a debt trap:
The very first thing to do is accept that you have gotten yourself in a mess because honestly, nothing good ever came out of denial. The longer you keep on denying it, the longer you deny yourself to actively do something about it.
Prepare a budget and stick to it
Analysing your sources of income and expenses would never go out of fashion. People with poor budget planning are only the ones who struggle with financial planning. Everyone should be aware of the top personal finance skills to help manage finances better.
Try to increase your income
This may sound very obvious that “if I could have, I would have”. But oftentimes, we miss these very obvious ways to earn us some extra bucks.
For example, Robert Kiyosaki says you could buy a house at a very low-interest rate and then rent it. The rent should be higher than your EMI amount so that you are left with some extra. Simple, no?
Credit card balance transfer
You can opt to transfer your credit card balance to another card that has a low rate of interest. However, you should only do this when there is a huge difference between the interest rates.
Opt for debt consolidation
This is the most efficient way of getting out of a debt trap. In this, you are to take a personal loan with a very low-interest rate and pay off as much of your pending debt as possible. Consolidating your debt means merging many of your debts into one so that you can opt for favourable payoff terms, low-interest rates, and low EMI.
Seek professional help to get out of the trap
There has been no one and will be no one who never required anybody’s help. Once you have accepted that you are stuck in a debt cycle, it is better to seek help from a professional who knows the system inside out and can help you get out of it.
Wouldn’t it be better if you get your complete financial planning done by them as well? Fret not. This solution is instant and very helpful. Visit Recipe by Finology to get a 360-degree analysis of the financial problems and solutions to those.
What have we learnt today? Sharma ji ke beti se kuch MAT sikho.
Loans are something that almost each one of us has turned to when in need and there is no shame in it. But poor management of funds could be very disastrous.
There is a reason why experiences are shared. So that you learn from those experiences and don’t repeat the same mistakes. Unlike popular opinion, you don’t really have to experience a thing to learn about it.
Till we meet again. Happy personal finance planning.
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