What is Debt Trap and Six Ways to Avoid Getting into it

What is Debt Trap and Six Ways to Avoid Getting into it

What is a Debt Trap?

Simply out, a debt trap is when you begin to spend more than what you earn, resulting in a situation where the debt you owe spirals beyond your control. For instance, you’ve taken out a loan, but aren’t in a position to repay that loan. So you take out another loan to pay off the earlier loan, and keep repeating this pattern. A debt trap becomes a financial quagmire that can get extremely challenging to get out of.

There could be several reasons that lead a person into a debt trap. Some of these are, losing your source of income or having to take a huge cut in your income, an unexpected exigency, poor budgeting, no savings, ignorance about spending. However, with smart financial planning and budgeting, one can learn how to avoid debt traps, and easier to get out of one.

How to Come Out of a Debt Trap?

Understand and analyse your financial situation

It helps to do a financial introspection, identify your pain points, and come to terms with the reality that you’re in debt. Once you’ve accepted that you’re in debt, identify the areas where you’re spending more, and consider whether you can curb some of those expenses. Draw out a financial budget and stick to it.

Invest in an emergency fund

Know that it’s financially prudent and pertinent to have an emergency fund, to help you deal with your immediate debts. Adding a small portion of your income to this emergency fund can help you get out of a debt trap in an easier manner. Work towards adding enough funds to help meet you with at least six months’ of living expenses. It is also financially prudent to invest in Public Provident Fund, National Savings Certificate, bonds and equities, which may eventually help you clear out some of your debts, if not all.

Lead a financially frugal life

As an individual’s income increases, it’s only natural that they may want to spend more. However, try not to get carried away with your expenses. Alter your initial budget slightly, and save more – in bonds, equities, add to your emergency fund. Check your credit score on a regular basis to keep track of where you stand. If you note a fall in your score, take immediate steps to improve your score.

Make timely payments on your EMIs and Credit Card bills

Not only is it important to pay off your bills and EMIs on a timely basis, it is equally important that these payments are made in full. Part payments will only keep increasing your debt and interest, eventually leading to a vicious debt cycle. Timely payments also positively impact your credit score, which will eventually help you on the road to financial inclusion and independence.

Consolidate your debts

You may find yourself in a situation where you took multiple loans to meet your different requirements. And now you’re in a debt trap. A viable solution for this could be to consolidate your debts – debt consolidation is an important step towards your financial independence. Consider taking out one single loan to clear out your existing dues, bringing down your multiple loans to one. This single loan will be easier to manage and you’ll have just one interest rate to think about.

Consider alternate sources of income

Try to have a passive source of income, such as from any rental property. Keep track of any insurance policies, and whether any of them are about to mature in the coming months, as the income earned on these policies could help repay some of your debts. You could also consider taking up independent projects to supplement your income.