Entering into a debt trap

Greed is a factor which makes the financial decisions for most people. Given an option, majority of us would prefer to retire rich fast or lead a better lifestyle among other things. Greed in the last three to four years, led many individuals into a major debt. Like a whirlpool once you get caught, it’s difficult to get out.

Why this happened and who is responsible for this is very important to understand so that none of us repeat the mistake.

Let’s go back to the years 2004-05. The property market was going up by 25-30% annually and the borrowing rate for loans was as low as 8-9%. Similarly the stock markets were going up. At times in a day small investors were making Rs 10,000 -15,000. Personal loans were given in the range of 15-16% to invest in stocks. If an investor held shares then one could also get money against those at better borrowing rates. What does his indicate? Opportunity to make money as the differential between the borrowing rate and property appreciations was as high as 16-17% and in the stock market it could be as high as 30-40%.

This is the situation greed had created. The story does not end here. Even if you are not keen on getting into this banks were so aggressive on lending money that everyday you would get marketing calls for loans at cheap rates. This would induce even a sane person to think why not make some money from this boom.

To worsen things, every third person became an advisor on stock and property market and would laugh if you kept money in a fixed deposit. At parties and social gatherings one will hear stories about people making big money from either property or stocks. People who in the normal course of life went ahead and bought their second and third house for investment purposes. For this, they started borrowing money from banks and every source to invest in stocks and real estate for making some quick profits.

But realty dawned in year 2008. The cost of borrowing for all loans has gone up by 2-3% annually. The property market is declining with a correction happening in some areas in the range of 20-25%. The Bombay Stock Exchange’s Sensex which was at a high of 20,000 plus, fell to 14,500 and no one wants to take a bet on when it will recover.

To top this, inflation rose to 11% making the cost of living more expensive. This sudden economic downturn has caught many investors on the wrong foot. You now have a property which is not appreciating and your banker has increased the monthly installment. So, from a positive of 20-25% you will technically get into a negative of 25-30% annually this year. You bought stocks with borrowed funds and all are down 30-40%. Still you are not selling with the hope that one day things will change. But your banker still wants his installment on time. Your monthly family expenses have gone up by 10-15% in the last two years, which is again putting pressure on your cash flow. Banks across the country have tightened their credit norms and are not willing to give more money if you don’t meet their new norms. Your broker is asking for money if you have overplayed during the good times and took large exposure in the Futures and Options segment.

This is the kind of crazy situation in which most people are caught and don’t know how to get out. This is also known as a typical debt trap.

The question now on your mind is what happens if this situation continues for some more time. Some people will get into the worst trap if they start making payments with their credit cards where money comes in at a higher rates and your cash outflow in the long run would be much higher.

The bottom line is that money never comes easy in Life. If you are in a debt trap, be more cautious the next time. Don’t let greed cloud your financial decisions in life.