Imagine a situation where you have taken a huge loan or several such loans. And on top of that, you don’t have money to pay the loans. So, what do you do? You have to take another loan to repay the loans. Thus, you end up being trapped like a warrior surrounded by the enemy in the form of excessive debt from all sides.
Do you want to be in the above situation? The obvious answer is a big no. But, what if you already are in such a situation? What can you do to avoid being in such a situation known as a debt trap? The answers to questions like these will be answered here.
Let us start with the most basic of all questions –
What is Debt Trap?
A debt trap is a situation where you are compelled to take new loans so that you can repay your existing loans. When you pay the EMIs, the repayment goes towards paying the interest rather than the principal. This implies the interest on the existing loans starts to pile up.
Debt by itself is not bad. Debt may be required for various purposes such as expanding your business or fulfilling your working capital requirements. But, being in a debt trap is a serious problem. Here are some of the things you can do to avoid being in a debt trap.
Ways to Get Out Of the Debt Trap
Take debt only when you need it
Debt can be broadly classified into 2 types – one which generates revenue and the other which does not. Avoid debt that does not generate revenue in every possible way. For instance, debt that is taken for expanding the business, research, development, etc. would generate revenue for the business. Such debt can be repaid if things go by the business plan. Debt taken to buy the latest technology car, a new phone or any other item that may not generate revenue for the business should be avoided.
Must have an emergency fund
Unexpected events happen in real life despite having foolproof planning. For instance, in recent years, covid and lockdowns affected finances. Having an emergency fund would prevent you from taking debt if these unexpected events happen.
Hospital expenses can take you on the road to debt. Hence, having adequate health insurance is a must. An emergency fund can also help in meeting unplanned expenses that are not covered under any of your insurance. Insure yourself against unforeseen events that can burn a hole in your pocket.
Plan and budget your expenses
Maintain a proper budget for your expenses and income in the months ahead. This would help you know the large expenses and the pattern of income and expenses.
Let the budget go through a stress test. If you are taking debt for a business try to answer these questions. What if the margins of the products you are selling are lesser than anticipated? What if the expansion you are planning through debt takes a few more months to get completed? Will you be compelled to take excessive debt in these scenarios? Will you be stuck in a debt trap?
Reduce Wasteful Expenditure
Do you need that office in a posh location? Or will a no-frills office in a good location that caters to customers, but saves on rental costs do?
Can you avoid discretionary expenditures funded by debt such as luxury vacations, luxury cars, visits to premium restaurants, etc? You can very well fund these indulgences with saved money if you can afford them. Alternatively, you can slightly alter your lifestyle and spend mainly on the things you need.
Follow the simple rule – Think before you spend.
Paying off high-cost debt with cash flows
If you have taken a loan in the past and now you have good cash in your hand such as money you got from the sale of property, use it to prepay the high-cost debt with it. Similarly, you can consider selling your investment in shares and mutual funds to repay your debts, in case you are having one.
| Do’s | Don’ts |
| Monitor your income and expenses to see where your money comes and goes | Avoid impulse purchases |
| Consider consolidating multiple loans under a single loan if you are in a debt trap | Debt that does not lead to the generation of revenue |
| Be insured | High-cost debt if you are in a debt trap |
| Increase your income | Credit card overdue |
FAQ’s
Q1. I am already in a debt trap. How to get out of it?
Ans– The first step towards solving a problem is to acknowledge it rather than live in denial. If you are in a debt trap, recognize the problem. Make a list of all debts that you have. Replace the high-interest debt with new debt with lower rates of interest. In certain cases, repay the high-interest debt. For instance, some businesses make the mistake of funding their business with a credit card. This credit card debt carries huge interest and also affects your CIBIL score, which impacts your ability to get future loans. This credit card debt needs to be repaid in totality.
You can consider debt consolidation which involves taking a single loan to repay all the existing loans. Till the time you are in a debt trap, refrain from buying all luxury products. Seek help from professionals dealing with debt trap issues if you find it difficult to deal with them on your own.
Q2. How will I come to know that I am in a debt trap? What are the indications?
Ans: In case you are in a debt trap, your fixed expenses will account for a significant proportion of your income. You might be forced to take another loan to pay the existing one.
Q3. How to understand the debt trap in simple words?
Ans: In simple words, a debt trap means a situation when you are unable to pay your debts, be it your credit card bills or the EMI of a home or a business loan.
Remember that you are a warrior who can deal with the challenges thrown at you. After following these simple things, have faith in yourself that you will come out victorious.