Remember the fable of a frog that boiled itself to death after falling into a pot of water? The water was pleasantly warm when the frog fell in, but the amphibian simply adjusted its body temperature to stay inside. When the water reached its boiling point, the frog could neither manage its body temperature nor jump out successfully. Same is the case with a large section of people who fall into a debt trap without realising it. Like slow poison, it erodes their quality of living and peace of mind.
What is Debt Trap?
Typically, a debt trap is the result of mindless borrowing without checking if one has the ways and means to repay it. Loans are the easiest tools at common man’s disposal to fulfil his dream of buying a house or car, or to meet medical expenses. As such, debt is unavoidable for most people. But debt trap is something that everyone should be wary of. Let us look at some warning signs that indicate a person is falling into a debt trap.
- Too many loans: You have too many EMIs to pay throughout the month on several loans you have taken. The risk of defaulting on repayment is high, and it will have a cascading effect if missed. If more than half of your monthly income goes out as loan repayment, you are in a debt trap. EMIs are not the only villains. Generally, if your monthly expenses, say utility bills and house rent, take up more than 70% of your earnings, your chances of falling into a debt trap are high. Such expenses should not cost more than 50% of your income. And if you do not have the money to pay your utility bills, it is a sure-shot sign of gliding into a debt trap.
- Betting on future income: If the thought of festive discounts and sales thrills you to such an extent that you decide to opt for a loan with an EMI that only a revised salary can pay for, then debt trap is nearby. What would happen if you lost your job or did not receive the expected increment? Also, there are loan products whose EMIs increase after a few years. Such interest rate spikes can lead to almost 20% rise in EMIs, which monthly salaries alone would not be able to offset. So if you do not have other income sources and are still gung ho about future income-based borrowing, your chances of getting into a debt trap is high.
- Borrow to meet daily needs/pay EMIs: If you do not have any money left in your bank account and have missed EMIs, you have no choice but to borrow from relatives or friends. Banks won’t lend anymore as you have a poor credit score, but NBFCs might lend you cash at a higher interest rate. This would only make you fall deeper into the debt trap.
- Credit cards: The cash advance fee on cash withdrawal using a credit card comes to 2.5% to 3.5% of the transaction amount per month. If credit card payments are put off by paying the minimum due amount, which in fact is quite low, your repayment capacity would be severely reduced by the high-interest rates. If the credit card limit is exceeded, it is high time you track your finances.
Debt Consolidation Loan
While lifestyle changes and finding new ways of income can save you from the debt trap, the most important step is to take a debt consolidation loan. For that, all outstanding loans and their interest rates should be calculated, and a lower-cost personal loan that can clear all of them should be taken. A debt consolidation loan allows you to focus on paying only one pending loan. A debt consolidation loan also reduces your chances of missing a payment or making a late payment and may improve your credit rating. Professional loans are the best way to make a new start for working professionals who have fallen into the debt trap. Professional loans offer competitive interest rates and are priced better than personal loans. What matters most is making the right choices to live a debt-free life.