Debt trap


Debt looks easy while taking the money and because of this most people indulge neck deep in it without understanding the fuller implications of repayment burden. Even if it is understood to a certain extent people are not able to really curb the temptation if raising funds through debts because they consider it is the only way to finance their dreams and aspirations. Nobody is alone in committing the mistake and it includes very well most of our friends and relatives. Falling into the trap may be due to:

Credit looks cheap initially and easy to get these days, but it is surely not good for financial health in the long term.

Another reason is ‘show off’ to look like maintaining status as compared to friends and relatives.

Let us take the case of Mr.D, a middle level marketing executive with a multinational firm, who was never conscious about how much of his pay check was going towards repaying debt, until he and his family were thinking of buying a house. It was only then that he realized almost half of his salary was used to repay the car loan, plasma, music system, computer and credit card bills.

Perturbed that he wouldn’t be able to buy a house for next five years ‘D’ asked his chartered accountant to help him clear his debt at the earliest.

This is what basically happens when you finance your lifestyle through debt. You tend to forget that at no time the expense should exceed the income if not in no time, people get trapped in debt.

A Financial planner of Moneycare Financial Planning said that no matter whatever is explained to them with theory or numbers, they don’t understand it. Only if they realize the situation and genuinely want to get out, things would fall in place. ‘D’s CA told him to pick up a paper and list all his outstanding loans. He also wanted him to write the interest he is paying on them. This made him realized his fiscal position.

One of the most important steps is to evaluate the debt to find out which is the most expensive one. For example, if one has a huge credit card outstanding, at 40% interest per year that could be the most expensive credit. Then it is better to substitute it with a personal loan, which would cost around 14-16%. One can also avail cheaper loans on an insurance policy, provident fund and such instruments.

In other words, reducing the rate of interest is the right move. You can check with other banks for cheaper rate. Alternatively, you can also try for soft loans from friends and relatives.

However, don’t lose sight of other credit it in your enthusiasm to eliminate expensive loans. It is very important that you don’t default on other loans. It is very important that you keep on paying the equated monthly installment or minimum amount due as there is a chance that banks may term you as a defaulter. With credit information bureau ready to take off, it may affect your creditworthiness.

Most people start the program very eagerly, but they don’t follow it enough. If you don’t have a definite plan and if you don’t stick to it, it is not easy to climb out of the debt trap. You have to make a conscious decision to change your lifestyle.

The point is: stick to your repayment plan and, at the same time, don’t accumulate debt. One can also think of making part-payment of outstanding loans with returns from investment.

Surely one wants to wipe out the entire outstanding loans at the earliest. But overdoing it may affect his financial health in the long term. For example, don’t wait to clear off the loan to start your retirement plan. Time is a major factor when it comes to long-term investments. Stick to repayment plan and long-term investment plan at the same time. Waiting to retire all debt in say, five years, would cost you a lot when it comes to your long-term asset building plan. One may also lose heavily due to the power of compounding.

Employed executives can always use one-time lump sum amounts such as bonus, festival cash gifts, income from investment to prepay some loans.

How not to be trapped,

Debt repayment shouldn’t be more than 20-30% of income. Switch over to lower interest rates or look for soft loans from friends. Try to prepay part of the debt. Don’t overreact, as it may affect the long-term investment plans.