In a debt trap? Tips on how you can get out of it

Harshala ChandorkarCIBILI have come across young and smart working professionals who had got into a debt trap but were able to navigate through it and rebuild a good credit history and healthy credit score. Shourya Rathore (name changed) a 28 year old software engineer had accumulated credit card debts on 3 credit cards and failed to pay EMIs on the car loan he had availed. In order to pay his credit card bills Shourya applied for a personal loan to a bank but could not get it due to a low CIBIL TransUnion Score (credit score) and delinquent credit history. He then approached CIBIL to understand the problem and on checking his credit report realized that his delinquent credit behavior was the cause of his loan rejection. Shourya then researched and discovered that he had got into a debt trap and must now work consciously to get out of it and rebuild a healthy credit history and high credit score. His determination yielded results and within two years’ time Shourya had cleared most of his debts and started paying his credit bills and loan EMIs regularly month on month. As a consequence his credit history had improved and so had his credit score. Based on Shourya’s experience, here are some guidelines on how you can successfully navigate through a debt trap:•Self-awareness: Understand your financial situation and various financial obligations and responsibilities you have. Self-awareness of your financial status will help you spot an upcoming debt trap way before it’s too late. Frequently calculate your income to debt ratio. If over 45% of your income is going into paying EMIs, it's a cause for concern. The red light should flash if over 25% of your income is going towards the payment of EMIs of non-mortgage loans and discretionary spending.•Modesty is must: Adopt a modest approach and curtail on lifestyle expenses. Remember saving every penny counts when you want to get out of a debt trap. So take the bus instead of a taxi to work and cut down on similar such additional spends that you can avoid without compromising on basic needs like food and health. •Strategize smartly: The most critical step towards your journey to get out of a debt trap is to strategize on paying your loans and bills. Make a list of all your outstanding loans and then decide which of these you need to close on priority. The strategy should be to pay the most expensive form of credit first or to convert the expensive form of credit into a cheaper one. For instance- Credit card rollovers are the most expensive loans, with interest rates as high as 40% a year. If you find it difficult to pay a huge balance at one go, request the credit card company to convert it into a personal loan. Most credit cards companies are willing to let customers pay large amounts in 6-12 EMIs. If the sum is too big, they may even extend the payment to 24 months. Such personal loans are costly, with interest rates of 15-18 % a year, but this amount will be lesser than that paid while rolling over the balance. Shourya used this facility to repay their huge credit card bill.The aim should always be to move from the highest interest rate option to the lowest interest rate option of availing credit. So let’s understand some of these options a little more in detail.Loan against Gold: With this option, you can borrow money against your gold jewellery or gold coins. This is a very quick and efficient way of effectively utilizing the assets you own. The interest rate is around 15% p.a. So if you have a high interest loan, you can refinance it with a low-cost loan.Loan against Securities: This is another effective way to capitalize on your assets (without liquidating them) when you are looking for a new loan or looking to switch an existing loan. You may have invested in equity shares, mutual funds, LIC, etc. at some point. You can get loans of up to 50-80% of their security value.Use some of your savings for paying high cost debts: If the cost of the debt is high or if the debt has to be repaid urgently then you must use some portion of your savings to pay off these loans. Savings like fixed deposit, stock investments can be liquidated for paying off debts. However avoid liquidating life support savings like Provident Fund, Pension Fund or Insurance unless absolutely necessary.Review your credit report: Knowing what’s on your credit report will help you in managing your finances better. Review your credit report regularly to check how you are faring across your credit relationships and if your credit score is improving gradually.Remember it’s never too late to work towards improving and rebuilding your financial life. Many banks and credit institutions run credit counselling centers which can guide and help people to get out of a complex debt traps. It’s a good move to seek help from them if the debt trap looks unsurmountable.