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Do you feel trapped by never-ending debt payments? You’re not alone – millions struggle with the vicious cycle of debt traps. It’s a scary situation, but there are ways to escape this trap.
Besides personal debt traps, there is also a thing called “debt trap diplomacy” between countries. Keep reading to learn what debt traps are and the steps to climb out if you’ve fallen into them.
What is a debt trap?
In a debt trap, the borrower finds themselves in a cycle of requiring additional financing to cover their existing balances. The basic definition of a debt trap is when a person’s ability to borrow money exceeds their ability to repay it.
A debt trap occurs when you get yourself into a never-ending cycle of debt because you can’t get out of it under your existing loan obligations. Any additional debt, no matter how little, can quickly become a debt trap if payments are either missed or not made in full.
There are two parts to a loan from a moneylender: the principal amount you borrow and the interest rate, which is the percentage the lender charges on that amount.
Remember that every payment you make goes towards the debt’s principal and interest rates. This is a result of the amortising structure included in most loans.
It means that every payment goes towards paying off the loan’s principal and interest and that you’re supposed to pay it back over a certain period. If you miss a payment, you may find yourself in a debt trap where the principal and interest on your loan never go down and the amount you owe keeps increasing.
How to come out of the debt trap?
- Make a priority list
Unfortunately, people tend to spend recklessly without keeping track of their spending habits or expenditures. Creating a list to segment your needs into their respective categories can help you prevent this. Sort your requirements by priority level, from highest priority to least important.
- Save up for rainy days
If you want to stay out of debt, having an emergency fund is a good place to start. Set up enough money—at least six months’ worth—in case of an emergency. Having an emergency fund may be a lifesaver in times of financial uncertainty. In the short term, it will assist keep things running properly and out of the debt trap while things settle down.
- Stop taking on additional debts
To repay your existing obligations, you shouldn’t incur any further loans. To get out of a debt trap, this is a crucial step. Your financial burdens will grow as your monthly obligations increase due to your continued use of loans to repay existing debts.
- Pay off high-interest loans
You must define your loan as either short-term or long-term. Personal loans and credit card debt are examples of short-term debt, whereas mortgages are examples of long-term debt. Once this is out of the way, you can work on paying down the higher-interest debts.
- Automate utility and EMI bills
You may automate your EMI and utility bills with a bank or another applicable institution. You must always pay these invoices on time since they are crucial.
- Think about consolidating your debt
Combining your debt into manageable loans might help you escape the debt trap. Taking out many loans with varying interest rates and repayment deadlines is a headache you can avoid with this alternative.
One way to minimise your EMI outlay is to refinance your existing debt into a new personal loan with a lower interest rate.
- A safety net for your insurance needs
Ensure that you and your loved ones are protected from the unexpected by purchasing adequate insurance. With health insurance, you won’t have to worry about spending on medical bills, freeing up more money to pay off debt.
Understanding debt trap diplomacy
Another type of debt trap that exists that goes beyond individuals or businesses is debt-trap diplomacy.
The phrase “debt-trap diplomacy” refers to an international financial arrangement in which a creditor nation or organisation lends money to a borrower country entirely or partially to gain political influence.
In debt trap diplomacy, the creditor nations are said to have overextended credit to the debtor nations to get political or economic concessions when the debtor nations are unable to meet their repayment obligations.
Sometimes, the terms of the loans are not disclosed. Usually, the borrowed funds cover the cost of hiring contractors and purchasing supplies from the creditor nation.
Conclusion
Whether for individuals or nations, debt traps can have severe financial and political consequences. The cycle continues as interest piles up. If you find yourself trapped by debt, plan to pay off the highest-interest debts first while cutting expenses. Being disciplined with your money allows you to gain control and be financially free.
FAQs
Recognising a debt trap in India involves understanding your financial ratios and spending habits. If your EMIs exceed 50% of your income, or if your fixed expenses, including rent, utilities, and school fees, exceed 70% of your income, you may be heading towards a debt trap. Other signs include maxing out credit cards, accumulating more loans than you can manage, and being unable to save or invest. A rejected loan application can also be a clear indicator of a debt trap.
EMIs (Equated Monthly Installments) can become a trap if they lead to spending beyond one’s means. In India, the allure of EMIs is strong, as they allow for immediate possession of goods with deferred payment. However, if EMIs take up a significant portion of your income, you may end up paying much more due to interest and processing fees, leading to a potential debt trap. It’s crucial to understand the full cost of purchases made on EMIs and avoid letting them exceed 30% of your monthly income.
The International Monetary Fund (IMF) plays a pivotal role in the global economy, including India’s. It provides policy advice, financial assistance, and technical assistance to its member countries. The IMF promotes financial stability, international trade, and economic growth while discouraging policies detrimental to prosperity. It offers loans to countries with balance-of-payments difficulties and assists in economic policy implementation. The IMF also issues Special Drawing Rights (SDRs) to supplement member countries’ reserves.
Credit cards can become a trap when misused. In India, where credit card usage is increasing, the trap is often set by high interest rates and the temptation to make only minimum payments, which leads to an escalating debt due to compound interest. Responsible use, such as paying full balances on time and understanding the terms and conditions, can prevent falling into this trap. It’s essential to budget expenses and avoid using credit cards for cash advances or as a substitute for emergency funds.
To clear a loan quickly in India, prioritise repaying high-interest loans first, such as credit cards and personal loans. Make larger payments than the minimum due, and consider making lump-sum prepayments when possible. Reducing expenses to free up funds, increasing income through additional work, and refinancing for better terms can also accelerate loan repayment. It’s crucial to maintain a disciplined budget and avoid taking on new debt while paying off existing loans.