- Date : 27/10/2020
- Read: 5 mins
A little reflection on your money behaviour and spending patterns can help you avoid falling into a debt trap.
Living life in this modern age without taking on any debt seems almost impossible. And that’s okay because not all debt is bad. There’s good debt and there’s bad debt; it all depends on how you manage it. While effective debt management is central to personal finance and there are various debt management strategies, the best and most basic advice is to avoid debt or take on as little of it as possible. And that’s possible if you are mindful of your money behaviour and buying decisions.
Here are some of the most common products and money habits that push people into debt:
1. Constantly upgrading your gadgets
This was not something people had to consider 20 years ago. But now, with the proliferation of gadgets and various upgrades and models being released every few months, you have to be mindful. Either due to societal pressure or personal preference, wanting to have the latest high-end smartphone model or acquiring that snazzy pair of noise-cancellation headphones can push people into debt. Using a credit card for such purchases even when you know you can’t afford it and opting for ‘easy EMIs’ can add unnecessary financial burden. Online sales promotions that advertise attractive offers on credit cards and easy consumer durable loans don’t help the cause. They can make you believe you need to get everything as long as it comes with an appealing offer.
Related: How to be on the right side of debt?
2. Getting new loans to repay previous debt
When your EMI is due or when you have to return the money you borrowed from a friend or relative, it's tempting to take a new loan to be able to clear your previous debt. But that’s exactly what falling into a debt trap is like – it becomes a never-ending cycle. At first it may seem a smart solution, but it’s not. Your interest burden only keeps increasing and each new loan amount will be exorbitantly more than the original amount of your first loan. While debt management and getting out of the debt trap can be tricky, there are some useful and proven debt management and debt reduction strategies depending on your financial situation, such as the debt snowball method.
3. Taking personal loans for avoidable expenses
Personal loans are easy to get because they are unsecured loans and don’t need much documentation. But because of that very reason, they are high-interest loans. The easy accessibility of money through personal loans can make it easy to take one for expenses that can be avoided. Many financial institutions also market personal loans as ‘wedding loans’ and ‘travel loans’. Both of these expenses can be managed in a way that fits your means, or you can save up more instead of taking a loan. Personal loans can be useful in times of medical emergency, but it shouldn’t come to that because it’s more prudent to have a comprehensive health insurance policy in place for you and your family.
4. Letting EMI outgoings exceed 50% of your income
EMIs form a part of life today. Whether you’re applying for a housing loan to buy your first home or paying off your college education loan, it’s hard to avoid them altogether. However, you need to evaluate what percentage of your income goes into paying your combined EMI outgoings. Anything above 50% can be problematic and a sort of red flag – after all, in addition to EMIs you will have other fixed expenses and you will also need to put aside some savings. This may not be sustainable and it can push you to take on new debt. Another reason why you should aim to lower your EMI burden is because of the uncertain nature of life. Thanks to the pandemic, you would have realised how hard it is to have any stability or certainty. The fewer monthly obligations you have, especially in the form of EMIs, the better it is.
5. Withdrawing cash on your credit card
Credit card cash withdrawals aren’t the same as debit card cash withdrawals. When you use your credit card to withdraw cash from an ATM, what you’re essentially doing is taking a short-term loan. You should avoid this, even though it may seem convenient. Another credit card related behaviour that pushes people into debt is not paying their credit card dues on time. Often, people pay only the minimum due on their credit card statement, which is conveniently low, and roll over the rest without realising how much more it’s going to cost them. The monthly interest rate is usually between 3% and 4%.
With the way things are right now, even if you haven't lost your job or gotten a pay cut, it is imperative that you remain financially cautious. This means not taking on new debt, having a strong emergency fund, and not relying too much on EMIs and credit cards. This eBook will help you chalk out a course of action that is not a theoretical castle, but a practical, solution for positive outcomes. The simple six month plan will help you emerge out of the debt trap, and set course for financial security.