Debt, when managed prudently, can help you accomplish your financial goals and satisfy your needs. That said, one small misstep and you can quickly find yourself trapped under mounting debt. In addition to causing you loads of financial stress, overwhelming debt can also significantly affect your mental health. Such high levels of debt are what most financial experts call a ‘debt trap.’ If the question ‘what is a debt trap?’ is running on your mind right now, here’s everything that you should know about this phenomenon.
What is meant by a debt trap?
Technically, a debt trap is a situation where you’re forced to take fresh loans to repay your existing debt obligations. And before you know it, you get stuck in a situation where the amount of debt that you owe takes a turn for the worse and spirals out of control. Such a situation typically arises when your debt obligations exceed your repayment capacity.
For instance, when the income that you generate is not enough to clear your debt, the interest on the outstanding loan amounts starts to pile up quickly. This forces you to avail fresh loans to clear off the piled up interest, thereby landing you in a debt trap.
How to get out of a debt trap?
Now that you know the answer to the question ‘what is meant by a debt trap?’, let’s take a look at some of the ways in which you can get out of such a precarious situation. While it is an unfavourable situation for any person to be in, a debt trap is not the end of the world. Here are some suggestions that you can use to resolve a debt trap.
Stop taking on more debt
The first and foremost step that you should take is to stop availing more loans to clear out your existing ones. These loans only serve to add more financial and mental stress, and they can increase your obligations exponentially.
Prioritize getting rid of high-interest debt
When you’re on a mission to get out of a debt trap, the next thing that you should do is focus on clearing out your high-interest debt obligations. Unsecured loans such as unpaid credit card bills and personal loans usually carry the highest amount of interest among the various types of loans. Since these loans can drain your finances quickly, clearing them out on a priority basis can free up some of your money, which can subsequently be used to pay your other EMIs and loan obligations on time.
Start budgeting your expenses
Creating a tight budget and changing your habits and lifestyle is an essential step that can help free up some of your income. Reducing the amount of unwanted expenses that you make leaves you with a surplus amount, which can then be used to pay off some of your monthly debt obligations and EMIs. Furthermore, this will also allow you to save up some money on the side, which you can then use to make lump sum pre-payments and part payments.
Consolidate your loans
Having too many loans can make it harder for you to keep track of them and pay their monthly EMIs on time. This increases your chances of missing out on a monthly payment, which can worsen your situation. Consolidating all the loans into one single large loan obligation allows you to better manage your debt situation, and it leaves you with just one single EMI payment. Consolidation also enables you to move from high-interest rates to relatively lower interest rates.
Leverage your investments to repay debt
If you possess any investments such as bank deposits, mutual funds, or even equity, you could use them to reduce your pending debt obligations. You could use the profits from the sale of your investments to pay off a part of your loans to bring your debt levels down. Once you’ve settled a majority of your loans, you can focus on rebuilding your investments back up from scratch.
Now that you know the answer to the question ‘what is a debt trap?’, always make sure that you steer clear of such a situation. To prevent yourself from falling into one of these traps, try to avoid the use of credit cards for regular or large expenses. This way you can ensure that your debt situation stays under control. If you’re still unsure of how to go about clearing your debt, you could always seek the help of professional debt counselling agencies.