A debt trap is a situation where a person is forced to take new loans to meet debt obligations
India has a surge in consumer borrowing as access to credit cards, personal loans, and buy-now-pay-later schemes becomes easy. While credit is useful when managed responsibly, it carries the risk of falling into a debt trap. Here is how to avoid that.
Understanding the debt trap
A debt trap occurs when an individual or household borrows money to meet expenses but struggles to repay the loan, leading to a cycle of borrowing and mounting interest.
Causes of debt traps
Overspending.
Poor financial planning and budgeting
Unexpected financial emergencies.
Strategies to avoid debt trap
Prioritise your needs
Categorise your needs into essential, semi-essential, and non-essential items. Prioritise essential items necessary for survival and basic well-being. Consider minimising expenses on semi-essential items that enhance comfort but aren't crucial.
Stick to a budget
The foundation of financial stability lies in budgeting. Track your income and expenses meticulously. Allocate funds for necessities, savings, and discretionary spending.
Build an emergency fund
An emergency fund acts as a buffer against unexpected expenses, reducing the need to rely on high-interest loans. One effective way to build an emergency fund is by saving an amount equivalent to six months' salary. This fund serves as a safety net in case of job loss, injury preventing work, or unexpected essential expenses.
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Ensure adequate insurance coverage
The sooner you purchase insurance, the lower your premiums will be. With proper coverage, you can focus on paying off debt without the worry of increasing medical expenses.
Consider debt consolidation
Debt consolidation involves taking a single, lower-interest loan to pay off multiple high-interest debts, simplifying repayment and potentially reducing the overall interest burden.
“People take debts for mostly avoidable reasons. There is no sense in looking for immediate gratification by taking debt and after that feeling the stress and not even being able to use what was bought on debt,” said Suresh Sadagopan, managing director & principal officer at Ladder7 Wealth Planners.
“It may be a much better idea to save up and then buy whatever is the object of desire. The only thing here would be that one will have to wait for a few months before one could buy the item or avail the service. But this way, one can truly enjoy the product/ service with stress or guilt, he said.”