Overcoming debt trap to achieve financial freedom

Adhil ShettyBankbazaar.comUnlike the traditional belief that debt is a sin, the ‘right’ amount, if taken keeping in mind one’s repaying capacity debt, can be useful. However, any indiscretion in availing loans can see you slide into a financial nightmare, getting out of which can take some doing. But before we delve into those steps, let us look at what can lead you to a debt trap.How individuals land in debt trap Living beyond the means: There’s an old saying, “cut your coat as per the cloth”. It means that your expenses should be within the limit of your earnings. However, often people use different kinds of debt—personal loan and credit cards—to have a lifestyle that they would otherwise not have been able to afford with their salaries.Swiping your credit card more often than your debit card: When you swipe your debit card, you instantly get an SMS saying how much is left in your bank account. A reducing balance in your savings account can play on your psyche, and you would probably restrain yourself from using it for unnecessary expenses. However, when you swipe your credit card, all you get to know is how much more you can still spend i.e. your remaining credit limit. This would have an entirely different psychological impact on you than the reducing savings account balance, and may cause you to spend more when you should probably be cutting your expenses.Not able to differentiate between good and bad debt: Taking a loan for creating assets such as building a house, starting a business, funding higher studies or learning a new skill is not bad as long as it’s taken keeping in mind your repaying capacity. However, taking a personal loan for discretionary activities such as going on extravagant foreign vacations, buying expensive gadgets, throwing lifestyle parties, often is the most common reason for individuals falling into a debt trap.Borrowing for investment: This is one of the biggest financial mistakes a retail investor can commit. Often, investors take a second home loan to buy a property for investment even when they are already paying the EMI for first home loan. Then there are the adventurous investors, who take leveraged position in the stock markets. For example, by keeping a margin money of Rs 1 lakh, they proceed to trade in stocks for Rs 5 lakh. The balance Rs 4 lakh is treated as a loan by the broker to the investor, on which the latter has to pay an interest. By taking such bets, they are exposing themselves not only to high interest rates to be paid to the broker, but also to trading losses which can be debilitating. Know when you are in a debt trapThere are signs that tell you that you are either in a debt trap or just on the verge of falling into one. Here are some of them—learn to recognize them and studiously avoid the debt traps they lead to.Not able to fully pay the credit card bills: If you are not able to pay the entire credit card bill, the credit card company would charge an interest on the amount outstanding at an exorbitant rate of 2-3% a month. And if you fail to pay bill on or before the due date, there would be a late fee over and above the interest on the outstanding amount. This interest would keep on piling, and in no time the amount due would explode to unmanageable levels.Failure to pay an EMI: Usually, you miss your EMIs in case of a job or business income loss. However, if you are defaulting on your EMIs, even when you are on a salaried job, it means you have taken debt more than your repaying capacity.Credit card expenses or EMI depleting a large chunk of your salary: If your credit card bills and EMIs are eating up to 70-80% of your monthly salary on a regular basis, leaving little money in your hand for savings or for necessary spending like your child’s tuition fees or insurance premium, you can rest assured you are in a debt trap.How do you get out of the mess?If you are in a debt trap, you need to take some harsh measures to get out of this situation. Retire high cost debts: While credit cards charge 24-36% interest on outstanding amount, personal loans are available at 16-20% interest. If your credit card dues are piling up due to non-payment of outstanding balance amount, take a personal loan (if your credit rating still allows you to) and retire the credit card debt as quickly as possible.If you have Rs 50,000 outstanding on your credit card bill and you are able to pay only the minimum amount due (5% of the total amount which is Rs 2,500), take a Rs 50,000 personal loan at 16% for three years, and pay off your credit card dues. On the personal loan, your monthly EMI is Rs 1,758, which is less than the 5% minimum amount due on your card.Restructure your loan: If you have missed your home or car loan EMIs, renegotiate with the bank terms of your loan. Even banks don’t want the loan given to you to turn into a Non-Performing Asset (NPA). Quite likely, they may bring down the rate of interest to help you repay the loan.Dig into savings: If you have any savings, use them to retire some of your debt and avoid paying high interest on them. Some of your savings—FDs or insurance policy —may be paying you less returns than the interest that you are paying. Get rid of the debt by liquidating these savings. Sell the second home: If you are paying two home loan EMIs, even as your personal loan and credit card dues are ballooning, sell the second home which you must have bought as an investment. You may not get the ‘right’ price, but you may get enough money to get rid of some of your debt from your books.Shun the extravagant ways: Get rid of your extravagant ways that led you to the situation at the first place. Stop using your credit cards, stop eating out regularly and going to fancy bars and restaurants, and defer all major expenses that you had planned. If you drive your car to office, explore public transport for sometime till you clear the financial mess you may find yourself in.