Loans

How to avoid the debt trap?

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Financial freedom is a prime aspiration for everyone. However, achieving financial freedom includes a complex process that requires utmost caution and budgetary research. An integral part of the journey to achieve financial freedom is a personal loan. Loans help an individual to protect life-long, hard-earned savings. The introduction of P2P loans has also helped borrowers massively in paying off savings-depleting expenses.

While personal loans provide an individual with a secure, financial, burden-free future, gross mismanagement can push a person spiralling into one of the most dangerous financial traps: The Debt Trap. A debt trap is when an individual avails too many personal loans that create a chain reaction of high-interest loans and the death of a person’s savings.

How to avoid debt trap?

Here is how one can avoid falling into a debt trap:

  • Avoid overdue: If you have taken a personal loan/loans, avoid missing paying the EMIs every month. Especially with credit cards, if you miss paying the monthly bill, you are charged with penal interest and a late fee plus GST. Missing the payment for several months compounds the penalty amount and makes it financially impossible for one to repay the instant loan.
  • Prioritize your needs: If you think you are close or have fallen into a debt trap, you can avoid further financial damage by prioritizing your essential, semi-essential and non-essential needs. Limit your expenditure to essential needs and avoid spending on semi-essential and non-essential needs. By doing this, you can save a good amount of money and draw yourself out of the debt trap.
  • Debt Consolidation loan: If you have multiple loans you have taken to pay for the previous ones, the best thing you can do is to consolidate them in one. Avoid online money lenders and take a debt consolidation loan from a good Peer to Peer lending company, to repay all of them. Using a debt consolidation loan, you can clear all outstanding debts and will be required to pay a single EMI instead of multiple EMIs.
  • Be disciplined: Financial freedom requires uttermost discipline on the borrowers’ part. To avoid the debt trap, you can follow a simple yet effective financial rule: your total debt should always be 1.5 times of your total asset value, 2 times if you have a home loan. Similarly, the sum of all of your EMIs should never be more than 50% of your total take-home salary. You can ensure this discipline by using an EMI calculator before taking a personal loan.

The reason why debt traps are dangerous is because of their tricky nature. Managing your expenses in the most disciplined way possible and can go a long way in protecting you from falling into a debt trap. You should always have a perfect idea of your revenue and expenses before you apply for loans online or take an instant personal loan. Personal loans can prove to be the best financial decision if managed well.

This article is authored by Nikhil Prabhakar, Head of Marketing & Products at RupeeCircle. He is an alumnus of IIM Ahmedabad & ESCP Paris and has 10+ years of work experience across multiple industries like Fintech, IT & Energy. He is an active investor across equity, derivatives, debt and real estate.

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