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What is Debt Trap? Here is How to Avoid It

What is Debt Trap? Here is How to Avoid It

Taking on some debt can help you manage acute financial stress. You can select a lender offering a low interest rate and make your repayment convenient and even choose a loan tenure that matches your financial ability. But taking on more debt than you can manage can wind you up in a debt trap. And getting out of it can be inconvenient.

This blog goes over everything you need to know about a debt trap and tips on avoiding falling into one.

What is a debt trap?

When a borrower’s debt obligations exceed their loan repayment capacity, they take up new loans to pay off their existing debts on time. Now, they must not only pay off their old loans but also their new ones. What’s more, the interest rates for different loans add up, making it impossible to escape debt.

Falling into such a never-ending cycle of debt is much easier than you think. Below we cover the most common reasons why people fall into it.

Reasons why people fall in debt trap

  • They take a loan amount they can’t repay

When borrowers take out large loans without considering their finances, they might struggle to repay them. Alternatively, if they apply for too many loans simultaneously, they may struggle with paying off each loan too. In both these cases, borrowers will have to pay additional debt to pay off their loans. And this leads them into an unending debt spiral.

  • They fail to make timely loan repayments

When borrowers do not pay off their loans on time, the interest on the outstanding loan amount increases. Some lenders may even add late payment penalties to this amount. If borrowers cannot pay this amount in full and in one go, they will have to take on fresh debt. Again, this results in a cycle of debt.

  • They don’t pay the credit card bill in full

Unpaid credit card dues often accumulate finance charges between 24-49% p.a. And if card companies reduce the interest-free period, new transactions also accumulate interest.

Alternatively, if borrowers only pay the minimum amount due on their credit card bills for a few months, the outstanding bill amount continues to accumulate interest.

Both these cases lead to mounting credit card debt. And it can also push borrowers into a debt spiral.

How you can avoid a debt trap

  • Pay off your high interest debts first

The longer you stay in a debt trap, the harder it is to come out of it. To get out of one, focus on paying off your high-interest loans instead of extending your tenure. This way, you’ll spend less on interest and use the amount to pay off your other loans.

  • Create an emergency fund

Before applying for a loan, ensure you have a fund dedicated for emergencies. Ideally, this account holds up to 6 months of your income. And when required, it can be used for loan repayment as well.

Thanks to an emergency fund, you never have to worry about extending your EMI payments due to a temporary financial crisis. Instead, you can make payments using your emergency fund and avoid penalties or mounting debt altogether.

  • Budget your expenses

If you’re planning to apply for a loan, it’s best to budget your expenses beforehand. This way, you aren’t strapped for finances for your regular expenses, and you can still make your regular EMI payments. But how do you go about it?

Well, calculate repayments before you get a loan first. Now check if you can pay the EMIs comfortably with your income without impacting your regular expenses. If not, create a budget and cut your spending on non-essential items. This will leave you with funds you can use for your EMIs.

  • Consolidate your debts

If you’ve already taken a loan and you’re struggling with keeping up with your debt repayment schedule, get a personal loan and consolidate your pending debts.

When you do this, you essentially pay off all outstanding debt with your personal loan. Now you can pay off this loan at a single interest rate as prescribed by your lender and pay off the loan at a term you set.

Now that you know all about debt spirals and how to avoid them, you can manage your debts better. That said, remember that consolidating your debt with a personal loan can work well when you choose the right lender. And if you want a personal loan for this purpose, turn to Tata Capital. We offer personal loans at affordable rates. The best part? You can even calculate repayments and choose a loan tenure based on your financial situation. So head over to our website to learn more about our loan plans. Apply for a loan with us today!

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