ARE YOU FALLING INTO A DEBT TRAP?
6 Signs You Are Heading Towards A Debt Trap
You could be heading towards a debt trap without even realizing it. Here are a few signs you should heed to, before it is too late.
How much debt do you have outstanding? Taking on some debt – be it a student loan or mortgage may be unavoidable for some people. Heck, some even call it the prudent thing to do.
But there is a fine line between being prudent and overdoing it!
When does debt start to become a trap? And do you get any advanced signals?
What are the signs that you are becoming reckless and irresponsible with your your borrowings?
How do you know if you can afford to take on this next loan without compromising on your lifestyle or being worried to death about how you are going to repay it?
How do you know if you are not falling into a death trap?
A job loss, a medical emergency, Christmas, weddings are some reasons which can force us to borrow beyond our ability to repay.
These sudden shocks can be tided over by maintaining an emergency fund.
What about Christmas? or large expenses? Sinking funds are a wonderful tool to help you with those.
However, it is the slow slide into a debt trap that catches you off-guard. Watch out for these six red flags to take corrective action before it is too late.
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Debt Trap – 6 Signs To Watch Out For
Your Monthly Loan Repayment Dues Exceed 50% of Your Income
How many loans do you have outstanding? What is the amount you have to pay each month on them?
If the total amount that you have to pay towards your loans is more than half of your household income, then you have a problem.
Clearly, you have bills to pay, mouths to feed. You need to buy clothes and gas for you car to get you to your work place.
If more than half your income goes to paying off your debt dues, you will have not have sufficient money left over for day to day expenses.
70% Of Your Monthly Income Goes Towards Fixed Expenses
Your loan repayments are not the only fixed expenses you have. You need to pay rent. Utility bills come in fast and furious. Same with your insurance.
Then once you pay off the fixed expenses, you have to provide for variable expenses, a portion of which are essential (like food or clothing).
The reason they are termed ‘variable’ is because you have some control on the amount you spend.
The point is that once you have provided for all your bills and fixed expenses , you aren’t done! Do you have enough left to feed your family? or clothes that keep them warm?
It is for this reason that your all your fixed expenses (including your monthly dues on your debts) should not exceed 70% of your income.
Crossing the 70% mark is an early warning that you may be heading towards a debt trap.
You Need To Borrow To Run Your Household
If you find yourself borrowing money to meet your regular expenses, then you could be in trouble.
- Had to borrow from a friend to pay this month’s rent?
- Did you use your credit card to buy a Christmas gift for your mom (and have been rolling over the amounts each month?)
Clearly if you are taking money from friends and family, asking your employer to give you a pay day loan or paying heavy interest on your credit card only to run your household, then you need to set your house in order.
You Take Out A Loan To Repay A Loan
Sometimes when you can’t repay a loan you may be tempted to take out another loan.
Defaulting on a loan can lead to serious consequences. Your credit scores will fall and you will owe more as interest and penalties. Moreover, debt collectors will often use threats to force you to pay up.
Such considerations may force you to take out another loan to repay the first one.
Having said that, taking out a loan may not always be a bad thing. Consolidating your loans may often be a good strategy. Replacing an unsecured loan with a secured one should reduce your cost of borrowing. Often if you find yourself unable to make a repayment, try making the payment as soon as possible thereafter, preferably within a few days.
If none of these work and you are forced to refinance your existing loan at a higher cost with no visibility on how you will repay it, then you need to seriously revisit your your finances.
Withdrawing Cash On Your Credit Card
This one is a big NO.
Make sure you are aware of the costs of withdrawing cash on your credit card. How much will you be actually repaying back?
It is very easy to get a cash advance on your card. All you will need is an ATM, your credit card and its PIN. Credit card companies charge an arm and a leg from borrowers who withdraw cash on their credit cards.
But what is the cost of a cash advance? You will have to pay an upfront fee, a higher interest rate.
Your cash advance balance is separate from the balance that results from your purchases on the credit card.
The cash advance balance is charged a higher interest rate and begins gathering interest from the day you withdraw cash. There is no grace period.
What is more, if you make the minimum payments due your funds will be applied to your purchases balance first before your cash balance.
Rolling Over Credit Card Dues
Your credit card is a convenience. Use it as that. Use a credit card for the ease it offers, or for its benefits and rewards.
Make sure you can pay off the entire amount due at the end of the month.
If you are unable to pay your bill at the end of the month then you are living beyond your means.
Using credit card debt as a way to fund your day-to-day lifestyle is a definite sign of a looming debt-trap.
What Can You Do If You Notice The Signs Of A Debt Trap?
Credit counseling can help you understand your situation and come up with practical solutions that will work for YOU. You can find a reputable counselor with the National Foundation for Credit Counseling (NFCC).
Think about what got you into debt in the first place? Was it the lack of an emergency fund or buying stuff you don’t need? Understanding this will help you change your habits so that you don’t fall back into the trap.
Also think of ways to increase your income. A side hustle, selling off stuff you don’t use are some ways to help you tide over your difficult times.
You might think that you are stuck with your situation and have no one to turn to for help. Remember you aren’t alone and help is always at hand.
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