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How to Avoid Common Debt Traps

How to Avoid Common Debt Traps

  • By Saral Credit
  • June 09, 2022

Most people take some form of debt at one point or another. Whether it’s credit cards or personal loans, home loans or business loans, it’s likely that you will use at least one of these financial products in your life. The good news is that contrary to what many people think, debt isn’t always a bad thing.

For instance, if you have to pay huge medical bills, then it’s better to take a small personal loan rather than empty your entire savings account. Even using credit cards in a responsible manner is actually good for your credit score. That said, if you are not careful, then debt can certainly grow into a powerful entity that can hurt you emotionally and financially. The following are some of the tell-tale signs that you should watch for to avoid falling into a debt trap and potentially getting your name on a loan defaulter list:

1.  Credit Utilization Going Above 35% Credit utilization ratio is the ratio of your average monthly spending with credit cards to the total limit on the cards itself. So, if you are spending around 30,000 INR per month with the cards and their combined limit is 1 lakh INR, then the credit utilization would be 30%. Credit utilization ratio can help you check your financial habits. It can also help in maintaining a high credit score. This is because a ratio above 35% is harmful to your score. This is why it’s recommended that you use your credit cards in a way that the average ratio is always below 35%.

2.  EMIs Exceeding Half of Income You should always be careful when you take personal loans, business loans, etc. This is because when you take a loan, then you agree to pay a certain amount of money every month for the EMIs. So, if you have taken multiple loans, then the actual outgo can go beyond a safe threshold. If it’s above 50% of your income, then it should be a warning sign to take control of your finances.

3.  Enjoying “Minimum Payments” too Much When you receive your credit card bill and are unable to clear 100% of the balance, then you can decide to pay the “minimum payment” instead in which you have to pay only 2% of the balance. This allows you to prevent any fine or penalty that might have been slapped on your account if you had not paid anything at all. Minimum payments are useful when you don’t have any savings left at the end of a particular month. However, developing a habit of these is never a good idea. This is because when you pay a minimum payment, then the rest of the balance i.e. the 98% of it that’s left is transferred to the next month and becomes a part of your debt. So, it’s best to clear every credit card bill whenever you can.

4.  Expenses Getting Out of Hand It might surprise you but there are millions of Indians who literally live paycheck to paycheck. However, you don’t have to be in a situation as bad as this to realize that you are inching towards bankruptcy or getting your name on a loan defaulter list. If your monthly expenses are higher than 70% of your income, then it can be considered something that indicates that you need to set up a budget and bring down the expenses. How Can You Prevent Debt Traps? To avoid creating a financial mess, follow these steps: Check your credit report from time to time and keep a close eye on your credit score as that represents your creditworthiness Use credit cards responsibly and try to use cash whenever possible Don’t get loans even when they are available at discounted rates. Get them only when you absolutely need them Create a budget and spend your money based on that only Make sure that you clear the credit card bills and pay the EMIs on time Personal finance can be tricky. However, it’s important that you take the responsibility as soon as possible so that you can lay the foundation of a safe and secure future. Good luck!