What is Debt Trap and 6 Ways to Avoid a Debt Trap

what is debt trap

What do most people do when they save money? They let go of something they desire today for the sake of a better lifestyle tomorrow. But today, with credit cards, EMI schemes, and loans, money is available at a click of a button, giving people the freedom to fulfill their desires as and when they occur.  


The easy availability of credit has made people very comfortable with the idea of taking on debt to meet their lifestyle demands. But this comfortability can sometimes make things go out of hand, and unfortunately, there are serious consequences to it. The most significant one is the debt trap.

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What is a Debt Trap?

debt trap is a situation where the amount of debt you owe gets out of control. Such a situation arises when you spend more than you earn. But life happens. Unexpected events, a decision to pursue an education or bad planning can push you into taking on debt that may take years to pay off.

In such a situation you are burdened by debt that has accumulated over time with huge interest getting added to it. You may be forced to take another loan to repay the previous loan where you pay interest on both the loans, adding to the sum. Over time, this gets out of control and exceeds so much that your repayment capacity falls short, and you get stuck in a cycle called the debt trap.

Such a situation usually arises when your debt obligations exceed your repayment capacity. For example, the income you generate is not enough to clear your debt. As a result, the interest standing up on your outstanding loan amount will begin to pile up quickly.

Common Causes of Debt

Let’s understand some of the main causes of debt. This will help you make better financial decisions and avoid debt.
  • Loss of income or low income
  • EMIs exceed 50% of your income
  • Fixed expenses are more than 70% of your income
  • Education costs
  • Unexpected emergency
  • Extravagant lifestyle
  • Bad budgeting
  • Depending on credit cards
  • Little or no savings
  • Spending future money

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How to Avoid a Debt Trap

Avoiding debt trap requires the right kind of financial planning and management. Here are 8 ways that can help you avoid debt traps:

  1. Identify the issue
  2. Analyse the situation you are in and identify the areas of concern. Create a plan to address the areas which are in your control. A detailed, meticulous review of your current situation could be your answer to your debt problems.

  3. Prioritise your needs
  4. After a thorough analysis:

    • Break down your expenses into essential, semi-essential and non-essential.
    • Segregate these expenses on the basis of priority.
    • Make behavioural or lifestyle changes to avoid spending on semi and non-essential items.
  • Consider debt consolidation
  • Debt consolidation allows you to take a single loan to pay off your different loans. Once you consolidate your debt, you just have to worry about repaying one loan instead of servicing different loans with varying rates of interest on different dates.

  • Leverage your investments to repay debt
  • If you’ve invested in high return schemes such as mutual funds, bank deposits, chit funds, or equity, you could use them to reduce your debt obligations. Once you’ve settled a considerable amount of debt, you can focus on rebuilding your wealth again.

  • Stop taking on more debt
  • Taking more loans to pay off your existing debt increases your financial obligations and adds financial and mental stress. So, avoid them altogether.

  • Build an emergency fund
  • It’s important to have a separate fund only to deal with financial emergencies. Ideally, an emergency fund has to be of at least 3 to 6 months of living expenses. This fund helps you to navigate through tough times without having to rely on a loan.

    You can park this money in various investment tools that assure high liquidity. Although a bank saving account is a good option to keep your emergency funds, it doesn’t give you good returns. You can consider parking your emergency fund in a chit fund that ensures quick liquidity and better returns.

  • Pay off your expensive loans first
  • If you’re dealing with multiple expensive loans and can’t handle all the loans simultaneously, then the best way to slow down stress is to pay off the most expensive loans first.

  • Look for ways to increase your income
  • One of the ways to get out of debt is to increase your income. You can use the extra income to pay off your debt faster. Pick up freelance jobs that are relevant to your skills, knowledge and experience.

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    Things to Evaluate Before Taking a Loan

    A loan may give you immediate access to money, but there are several costs attached to it. Therefore, you must evaluate the offer before you take it. Things to evaluate before taking a loan are:
    • Remember to read the fine print thoroughly.
    • Check the total cost of borrowing money.
    • Explore all online and offline offers to get the best deal.
    • Consider various other costs associated with the loan or EMI scheme, such as pre-closure penalty, late payment fee, processing fees, etc.

    The Money Club – A Solution to Come Out of Your Debt Trap!

    Debt consolidation is a financial strategy for people with credit card debt. Multiple debts are combined into a single debt through consolidation, which is paid off each month via a debt management plan or a consolidation loan.

    Debt consolidation lowers your monthly payments and lowers the rate of interest on your debt. This debt-relief option relieves people from the issues they face every month trying to keep up with multiple payments and multiple deadlines from various credit card companies.

    The simple solution is to make one payment to one source, once a month.

    Take part in an online chit fund scheme of The Money Club to be debt-free. It helps clear all your outstanding balances and helps you to convert your multiple payments into a single monthly payment.

     Listed below are a few reasons why you should consider consolidating your debts by taking part in a chit fund scheme:

    1. Single EMI Payment: It sometimes becomes quite difficult to keeping a track of various EMI payments. If you miss repaying any one of your EMIs, you may have to pay a penalty and your credit score is also adversely affected. To avoid such hassles, you can consolidate your debts with a chit fund. Doing this will allow you to make one payment every month, thus making repayments a whole lot easier.
    2. Lower Rate of Interest: You may find that the interest rate on the money borrowed through a chit fund is lower than the current interest rates that you pay. In such scenarios, borrowing from a chit fund for debt consolidation is a practical option.
    3. Quick Disbursal: The lump sum amount that you need, will immediately be disbursed after the bidding is over to your bank account.
    4. No Collateral or Security: You do not have to submit any collateral or security when borrowing money from a chit fund.
    5. Flexibility: One of the key benefits of getting money for debt consolidation through chit fund is that you can choose any repayment term between 1 year and 5 years, as per your repayment ability. You can also opt for a chit amount that is sufficient to pay off all your debts.

    How To Save Money So That You Don’t Fall Into A Debt Trap 

    Key Takeaways

    Healthy control of your finances can go a long way in avoiding debt trap and achieving financial freedom. So, if you are using a loan or credit to buy things or solve pressing financial goals, repay it on time to safeguard yourself from high interest rates and debt traps.