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Finance

Are You Falling Into a Debt Trap? You Need to Identify the Signs

There is a distinction between debt, some types of debt are not bad and are often necessary at times but there are signs that are typical of unhealthy personal finance and the possibility of falling into a debt trap
Are You Falling Into a Debt Trap? You Need to Identify the Signs
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Executive Director, Wealth Discovery
5 min read
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For most people, particularly the salaried class, many times it’s common to feel the pinch of cash crunch to meet all the obligations and at that time debt becomes an unavoidable part of life. To deal with those situations people often resort to a credit card or personal loan, but sometimes this easy credit may spiral them in the wrong direction. Using credit card is easier but people typically lose track of their spending, while paying through card instead of paying by cash, as there is no cash outflow in the transaction.

Sometimes an unplanned event such as a medical emergency, job loss, delayed salary etc. forces one to borrow beyond one’s repayment capacity, and these situations typically are the starting point of falling into a debt trap. These sudden shocks can be avoided by maintaining an adequate contingency fund and people mostly try to manage and get out of this as they at least know that they are in debt actually.  But it’s often the slow, gradual slide into debt that can prove more dangerous as it goes unnoticed till the person is deep in debt. There are several telltale signs that indicate that one is falling into a debt trap, the first and the most common sign is one when meeting monthly expenses without taking on extra debt becomes problematic. Some of the other signs that are typical of unhealthy personal finance and the possibility of falling into a debt trap are:

Rolling Over Card Bills: Skipping full payment of credit card bills is the most common and probably the first sign that you are falling into a debt trap. Generally the minimum amount only covers the interesting part of the total bill outstanding and if one only pays the minimum, one would never be able to pay off the debt and given the fact that the interest on cards are high as much as 36 per cent to 40 per cent annually, paying off credit card debt would be next to impossible. Another point to remember is that even if one clears 90 per cent of their credit card bill in a particular bill cycle the bank will charge interest on the entire amount in the next bill cycle and not on the 10 per cent outstanding. Therefore, it is always advisable to clear the full outstanding in one month rather than paying the minimum due amount every month.

Borrowing for Regular Expenses: If you have to borrow regularly to meet routine expenses such as rent, kids’ school fees, etc. then you may be sliding into a debt trap.

Paying One Debt With Another: Borrowing money to repay a loan - balance transfer from one credit card to another or taking a personal loan, gold loans to pay off your credit card bills, unless it is aimed at reducing one’s interest outgo is a clear sign of falling into a debt trap.

Cash Advance on Credit Cards: Taking a cash advance on a credit card is the worst thing that one does because it comes with a heavy cost - typically a fixed cost, plus interest amount of up to 48 per cent per annum. So whenever you take a cash advance on a credit card it shows the dire state of the financial condition you are in.

EMIs Exceeding Half of Income:  Compulsive spending by falling prey to ‘easy EMIs’, ‘discounts’, and ‘sales’ can strain your finances and push you towards a debt trap. Though these standalone EMIs may not be big, when you add the various EMI obligations, you may have little money left to spend on other things. If one is spending more then half of one’s income in paying off EMI’s then sure it is a sign of an impending debt trap.

Fixed Obligations Counting More Than Half of Income: Apart from EMIs one has to meet several regular expenses such as rent, society maintenance charges, kids’ school fee, utility bill etc. and if all these counts more than half of your income, than you need to be worried about your finances.  

Borrowing Based on Future Income: It is common for people to hope for the best and fail to factor in possible future glitches. So, borrowing based on current salary is fine, but not on-expected bonus or increments as it often leads to trouble. If one finds the need to borrow based on future payouts then there something seriously wrong with their finances.

Meeting Regular Expenses Out of Savings: If you are meeting your regular expenses out of your savings or contingent funds such as your retirement fund, emergency fund, children's education or the down payment that you had saved up for your first house, then it is surely a big reason to worry, because if you are hit with any contingency such as medical emergency or a job loss you will inevitably land in a debt trap that would be hard to come out of.

There is a distinction between debt, some types of debt are not bad and are often necessary at times for e.g. a home loan, a student loan or an emergency medical loan, however another form of debt, especially credit card loans are the worst kind and are the hardest to come out off. Credit card debt should be avoided at all cost, it is good to use a credit card to build one’s credit profile however efforts should be made to pay off the entire amount owed at the end of the month. Debt is not only a constraint financially it also takes a significant toll on one’s mental health, therefore if one finds themselves trapped in debt perhaps it is best advised to seek professional help.

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