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Tuesday, March 8, 2016

Debt Trap

 

Inflating prices of essentials, coupled with stagnating annual salary increments and indiscreet spending habits, are causing many individuals to sink into a bottomless debt trap. Essentially, we get into a debt trap when most / all of our incomes get consumed in repaying loans and/or debts.

Crawling your way out of a debt trap can be a process that drains you emotionally, physically and financially. Most debt survivors concede that a debt-ridden life is riddled with procrastination, compulsive borrowings and plenty of stressful moments.

Any lapse in debt repayment inevitably leads to a higher interest rate, which worsens the situation further by lessening your money outflow.

How to deal with a debt trap

The most effective way to combat a debt trap is to avoid it in the first place. If you are already in a debt trap or worrying that you are sliding there, here are four practical ways to avoid debt:

  • Mind your outflow: Human desires are practically endless. It's tempting to get carried away with what we erroneously assume are necessary expenditures, which is why it is helpful to keep reminding ourselves about what is a debt trap.

For a start, ensure that you live within your means. Your spending doesn't need to compete with your earnings, nor with your friends' spending. When your expenditure begins to outweigh your savings, it reflects an imminent debt trap.  Take stock of the situation and plan out your strategy.

Similarly, when your borrowings become an inseparable part of your earnings, the quantum of debt gradually becomes higher, dragging you into a deep debt trap. Every lender offering a loan calculates your DTI (debt-to-income ratio), which is a percentage of the income used for debt repayment. So the more your debt is as a percentage of your income, the lesser your chances of getting a loan.

 

  • No callousness on loans: Remember, loans are not something you can be flippant about. A loan should ideally create value for your asset and continue to augment its value as time goes by. A home loan is a perfect example of one such loan.

However, when you take a personal loan to fund a vacation or some other avoidable indulgence, you have a lot to worry about. You don't want to land up in a situation where you struggle with your EMIs linked to such loans.

 

  • Sound management of credit card bills – Optimally managing your credit card bills is a great strategy on how to avoid debt. Although it is okay to pay your bills via credit cards, you may want to curb the tendency to go overboard in unnecessary shopping excesses.

Remember, credit cards entail a high yearly interest rate of almost 36%. Regardless of what the 'due date' is, you will HAVE to make the bill payment at some stage, so might as well do that on time.  Any negligence in this regard could incur alarming consequences in the form of accumulating interest.

 

  • Inculcate budgeting: While formulating a strategy to get out of debt, make sure to include budgeting in your long-term plans, after discussing with your family or spouse.

Each month, allocate some amount to address contingency expenses (which do not include your monthly utility bills that are to be prioritized in any case).  You may also want to save 10-20% of your monthly income to build a post-retirement nest egg.

If your debt situation seems to be going out of hand despite putting in your best efforts, it is best to get professional help in order to get your financial life back on track. There is no shame in seeking expert advice when you need it, especially when it pertains to your family's financial health.

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