Millennials constantly endeavour to achieve financial freedom. While achieving this may not be easy, many people fall for shortcuts and ways to become entirely free of debt. Becoming debt-free may not always be a smart move. On the contrary, it makes sense to source loans once in a while to gain a financial advantage and maintain a good credit standing. While doing so, one has to be extra careful about repayments and avoid sourcing additional loans to pay off existing ones. This can otherwise result in a debt trap.
Here, we will discuss the debt trap in detail and explain how loans could sometimes result in a debt trap. We will also highlight ways to avoid or get out of a debt trap easily.
What is a debt trap?
A debt trap means a situation that makes it difficult or impossible for a borrower to make loan repayments. It arises when multiple loans are outstanding and multiple other loans being borrowed to repay previously sourced loans.
Whenever one borrows a loan from a bank or lender, there are two key elements involved:
- The principal loan
- The interest in the principal
While repaying the loan, one can only progress in repayment when the loan principal starts coming down. However, monthly loan repayment involves both the principal as well as interest. This is because loans often have amortising structures and are designed to be repaid through a series of fixed payments spread across the loan tenure.
When a borrower cannot afford to make loan payments, there are chances of falling into a debt trap. The question is how? Oftentimes, the principal amount doesn’t get reduced quickly and therefore, the interest keeps on accumulating. This makes it almost impossible to make loan repayments on time.
Although one should take loans from time to time, it is equally important to make timely repayments. Timely debt repayments can prevent one from falling into a debt trap.
How to Get Out of a Debt Trap Easily
Here are five ways to get out of the debt trap easily:
Identify the problem - Determine the exact problem and thoroughly analyse it to identify specific areas of concern. Segregate these as in and out of your control. Further, chalk out a plan for your debt repayments. Under this, specific aspects that need immediate attention and modification must be included. This will help you to acknowledge the ongoing predicament and help you in preparing a clear path for the future. Current debt problems can be addressed with a detailed review and this will help in arriving at a solution faster.
Prioritise spending – After conducting a detailed analysis, you can segregate essentials, semi-essentials and non-essential spending. Establish a list and segregate your needs. You must refrain from purchasing non-essential or luxury goods while experiencing a debt trap. Semi-essential expenses, on the other hand, may not be essential for your survival and are more about comfort. Avoiding such spending and looking for cheaper alternatives could be a good way to get out of the debt trap faster. Adopting appropriate spending habits can also have a positive impact in the long run.
Make lifestyle changes - To achieve expense reduction for getting out of a debt trap faster, you may want to adopt some lifestyle changes. For instance, you can aim to reduce the frequency of eating out. Preparing a monthly expense plan and keeping a tab of extra spending can help you adopt a less expensive lifestyle till you can get out of a serious debt trap.
Debt consolidation – If you have different loans with different interest rates, you can try to consolidate your debt using a personal loan with a lower interest rate. A single loan through a debt consolidation may be far more manageable instead of making multiple loan repayments every month.
Set up an emergency fund - Saving is a good habit. By saving some money every month, you can create a special fund for any emergency expenses. If there are any unforeseen medical needs or in case of situations like job loss, you can rely on emergency funds to sustain yourself. This can help in managing your expenses instead of further falling into a deeper debt trap.
While adopting certain good credit practices to get out of a debt trap, try to distinguish between good debt and a bad one. A debt that is taken for asset purchase can help in generating revenue in the long term. This is known as good debt. A loan that is taken against an asset is considered a bad debt as it cannot generate any revenue. Bad loans often lead to debt traps before we know it. Hence, you must stay away from bad debt and aim for good debt.
Good control of your finances will go a long way in getting out of a debt trap while enjoying financial freedom. Taking a loan can be good but repaying it on time is equally important to save yourself from a debt trap.
- How do I avoid the debt trap?
To avoid debt traps, it is important to know the exact terms of the loan agreement thoroughly. It is equally important to pay your bills on time. Chalking out a plan for managing personal expenses well can help in avoiding a debt trap while having loan obligations.
- Is the loan a trap?
A loan can quickly convert into a trap if it is not managed well and timely repayments are not made.
- What can lead to a debt trap?
A debt trap is often the cause of an improper loan repayment schedule and no control over spending while having loan obligations. A debt trap may also arise if one opts for multiple loans and credit facilities at the same time.
- What should you do if you find yourself trapped in debt?
If you find yourself in a debt trap, you must do the following:
- Plan your expenses
- Close smaller loans first
- Consolidate debt to combine all loan obligations into a single loan with a lower interest rate
- Can a debt trap impact my credit score?
A debt trap may impact your credit score if it is not handled well and loan repayments are not made on time.