What is a Debt Trap?
A debt trap is when a borrower is in a position to pay only the monthly interest and the principal is still left behind. The traps are formed by the purchase of many high-interest loans.
People fall under this trap mainly because of top-up loans, debt consolidation and finally paying only the minimum balance of a credit card. The important factor is that people don’t find themselves being under this trap for a long time.
Example of Debt Trap:
For example post 2010 in India, the government provided education loans for undergraduate and postgraduates. Which has given you an interest-free loan facility till you complete your degree. Post-degree completion the interest starts accumulating in your existing debt.
Most students who have taken education loans don’t have the awareness of the interest amount it has grown. As they don’t pay either the principal amount or the interest amount for so many years.
For the loan amount of Rs. 1.5 lakhs were taken for education. If the loan principal and interest amount are not paid for 4 years post completion of course.
The current payable amount will be around 2.5 lakhs. You are going to pay an extra 1 lakhs. This is completely due to your improper knowledge of debt management.
How the Debt Trap Cycle Works:
A debt trap simply works as a cycle, but the core point here is improper knowledge of debt management and improper knowledge of financial planning.
The initial phase of the debt trap starts with credit cards, education loans, and gold loans. This becomes a trap when you don’t pay their installments or EMI properly.
Let us see the cycle.
By the above cycle, you would have understood, how a debt trap can lead to losing all the important assets. When you have a proper tracking of budget, especially income, expenses, and debts. You will not fall into these categories.
Everyone will be having some debts. Even I too had all the debt materials 2 personal loans, which turned into loan consolidation, 2vehicle loans, and 1 gold loan as a history of debts.
What I did was proper financial planning and tracking of all my debts and EMI properly. Whenever I take a loan, the first thing I do is, take a dairy note every month of total tenures. Then will tick down the months in which I complete payment. This gave me the viability of the remaining months of payment and made my mindset to close all my debts.
Since the last two years, I don’t have any debts and I won’t take any other debts as I am more clear with goal based investments and the power of compounding.
How to Overcome Debt Trap:
There are only a few ways to get out of the trap. Here are the steps to follow.
1. Proper Tracking of Budget:
In some many topics related to financial planning of Fincareplan, we use to say proper budgeting. Of course, this is the most important and primary step to get out of all financial burdens to achieve financial freedom.
As I informed you earlier I managed to close my debts and not take any new debts.
- Maintain a proper diary or Excel to track your payments on the installation date of the month.
- More important is calculating all your income and expenses.
- Never try to get any type of expenses more than the income.
- Never get a loan to show you’re wealthy to others. This is done everywhere for marriage, car, and even home.
- Whatever it may be plan according to your income and do expenses within your income.
- Always have this in mind, you should save 30% of your income towards savings.
Proper budgeting is the starting point for financial freedom. Please have a look at how to manage your monthly budget.
2. Avoiding High Interest Loans or Debts:
- The biggest trap is taking a loan in an emergency and doesn’t care about the interest rate.
- Most people take these loans to handle both emergency and health issues.
- These are the trapping loans that will eventually increase your possibility of a debt trap.
- The way to overcome these issues is by having a proper emergency fund and health insurance with adequate coverage.
3. Avoiding Materialistic Dreams Over Loan:
Everyone has a dream, most dreams are materialistic like bike, car, home, etc. Once, people have been paid a salary of 30K or more, they are in a mindset to buy the whole world.
We won’t advise you to buy these above dreams at the beginning of your career. First, you should align your life securities like term insurance, health insurance, and emergency funds.
After that, you should focus on goal based investments. So, you should never buy these dreams through loans. Dreams should be emotional and should be achieved by the proper route map. So, avoid loans or EMI for purchasing any kind of materialistic deeds.
Consult a Financial Planner:
The final and most important in handle the debt trap is to consult a financial planner. It is not a compulsory move, but when you feel that you can’t control your debts.
When you can’t make proper savings or investments. When you feel, you don’t have enough time to track your expenses, debts, and investments. Then, you should consult a financial planner or fee-only advisors.
Make them understand your situation and the solution you need to solve your financial instability. Fincareplan provides complete financial, investment, and tax planning.
- Debt traps happen due to a lack of tracking of the debts we have and accumulating debts.
- These traps will spoil your life’s peace and happiness and may lead to personal bankruptcy.
- These can be resolved by proper budgeting, tracking of income and expenses, and avoiding high interest loans.
- Don’t buy your materialistic dreams with loans.
- If needed consult a financial planner or fee-only advisors.