When do we say that the borrower is in debt trap?
Answers
Answer:
1. Take Stock Of Your Debts
Organizing all the details of exactly what you owe is the first step that would take you closer to dealing with them. Start with making a list of your various debts with their EMIs, interest rates, and tenures. This will help you determine the most urgent or costliest debts.
2. Always Be On Time – Automate Your Payments
Committing to pay your debts needs financial discipline. Ensure your debts are being paid on time every month. Set an ECS mandate with your bank to automatically settle the EMIs on your chosen date. Timely payments not only keep reducing your debt through the tenure of the loan, but also save you from late payment penalties, avoidable interest, and damages to your credit score. Therefore, avoid making payments manually via cash, cheque deposits or even netbanking. Just save yourself the hassle, and automate your EMI and credit card payments.
3. Settle Costliest Debts On Priority
Once you’ve taken stock of your dues, target the costliest ones first. These are debts which, kept pending, will extract the highest interest. Paying high interest can drain your finances. For example, a home loan will have a relatively low rate of 8-9%. A personal loan can be upwards of 12%. Credit card debt is costly, with an annualised rate of interest exceeding 40% at times. There are also payday loans that can extract interest at the rate of 1% per day – or more than 365% per year! Therefore, look at your liabilities and attack the costly loans because often they extract the highest price.
4. Plan For Prepayment, Take Stock Of Your Budget
Having a monthly budget is a vital debt management technique. The first step in devising a budget would be to make a note of your income and expenses. This will help you think of various ways of reducing your daily expenditure. The money that is saved can be used to clear your debt.
5. Too Many Loans? Consolidate Them
Do you have several loans? Is it becoming difficult keeping track of all of them? Consider consolidating them into one loan, which will leave you with just one EMI. Personal loans, credit cards, and even home loans can provide you with this option, helping you close various debts, leaving you with just one loan to track. This also helps swap a high-interest loan for a low-interest one. For example, instead of paying 40% on credit card debt, you could instead move to a personal loan that charges you 15%.
6. Avoid Too Many ADDITIONAL Loans
While you’re already saddled with considerable debt, you should avoid taking on even more. Ideally, all your EMIs and credit card payments combined should be no more than 40% of your take-home income. If you go over this limit, you will be straining your finances and setting yourself up for considerable difficulty in case you were to lose your income for some reason.
7. Protect Yourself Against Economic Shocks
Economic and income shocks are those situations where you don’t have the income required to sustain your current lifestyle. For example, loss of employment could lead to loss of income, which may leave you unable to meet your regular expenses such as your EMIs. As a borrower, you must ensure you have sufficient liquidity for all situations. Create an emergency fund that can sustain you during such situations. Ideally, this fund should be 3-6 times your current monthly income locked in a fixed deposit or liquid mutual fund.
8. Protect Yourself Against Death, Disease, Disability & Damages
Insurance helps you protect you and your family against unforeseen events. A term insurance policy or a loan protection policy will ensure that even in your death, your family’s income needs will be taken care of and your loans would be settled. This would, therefore, help your family achieve such goals as homeownership. Similarly, hospitalisation, disability, or damages to property can make it difficult for you to meet your debt obligations, and therefore adequate insurance against such risks can help your debt repayment remain on track.
9. Step Up Your EMIs & Payments
Your income will keep increasing with time. This would allow you to make higher loan payments with time which, in turn, will help you get out of debt earlier. So make use of your investment income, annual hikes, windfalls, bonus incomes, and increase in salaries to make pre-payments on your loans or to step up your EMI. Pre-payments are normally charge-free on floating rate home loans but may attract charges on car loans, personal loans etc. However, getting out of debt is your objective, and pre-paying will help you reduce your interest out-go.