We often need money, and to fulfill those needs, we take loans, with personal loans being one of the most common. Taking a loan is not a bad thing; in fact, it helps you fulfill many of your needs. But are you really taking loans the right way? What if taking a loan ends up trapping you in debt? So, in this blog let's talk about how you can avoid falling into a debt trap when taking a personal loan.
What is a debt trap
A debt trap is a financial situation in which a borrower continues repaying existing loans while taking on new loans. Eventually, they become completely dependent on borrowing. This is called a debt trap. Instead of repaying their existing loans, the borrower keeps taking new loans to pay existing EMIs and credit card bills.
How it develops:
EMI bounce is one of the biggest reasons people fall into a debt trap.
Existing loans are already ongoing, and taking new loans at the same time is another major reason people fall into this.
Accumulation of several loans that you are not capable of repaying.
Often, in a hurry, repayment planning gets overlooked, and that is what traps us in debt.
Why borrowers fall into traps:
Poor budgeting, overspending, and the greed to have more often put people in the wrong situations. The main factors include credit cards and instant loans, which increase borrowing. In many cases, borrowers simply take loans without considering their impact, such as how they will repay them. They take loans without checking the monthly EMI, and later, when the loan defaults, they fall into a debt trap.
Common causes of debt traps.
When you understand these things, it will help you in becoming aware.
Overspending: Spending is a good way to fulfill your needs if it is planned properly. However, overspending unnecessarily increases your needs, which can lead to losses in the future.
Dealing with Multiple Loans, Credit Cards, and EMIs: Taking multiple loans at the same time is only good if you are capable of repaying them. Otherwise, it increases both your expenses and financial burden and pushes you into a debt trap.
Bad financial planning: We should always keep track of our spending. However, if for any reason you are not doing this, it increases your financial burden, and it is not good for your future.
How does a debt trap impact financial health?
Low CIBIL score: If you take multiple loans and, for any reason, are unable to repay them, your CIBIL score gets severely affected, which can create difficulties in getting loans in the future.
Increase financial stress: If you have the burden of paying multiple EMIs and credit card bills, it increases financial stress and pushes you into a debt cycle.
Loan defaulter stress: If you do not repay your existing loan on time, your credit score gets affected, and in the future, banks become reluctant to offer you loans. You may also be classified as a defaulter by the bank.
High financial instability: When your debt accumulates, your savings get exhausted, and eventually, your future plans, such as retirement planning and traveling, remain just dreams.
How to avoid yourself falling into a debt trap
Track your monthly EMI and expenses: Whenever you make an expense or take a loan, always calculate your monthly EMI, track all your expenses, and maintain financial discipline.
Borrow only what you need: Always borrow only as much as you need. If you borrow more than necessary and are unable to repay it, you could end up in serious financial trouble.
Maintain contingency funds: Building an emergency fund is a very good financial habit. If you do this, it can protect you during financial emergencies.
Avoid taking multiple loans: Taking multiple loans simultaneously can negatively impact your CIBIL score. If you fail to repay your EMIs on time, you may end up in a debt trap.
How to get out of this debt trap:
These are the following points you can consider to get out of the debt trap:
Debt consolidation: With debt consolidation, the EMIs of your multiple loans are combined into a single EMI, which helps you repay your loans more easily.
Prioritize high-interest debt repayment: If you have multiple loans to repay, start by paying off the loan with the highest interest rate. This will help you repay a major portion of your debt first.
Develop healthy financial habits: A healthy financial habit means keeping track of all your expenses and bills, spending wisely, and repaying all your loans on time.
FAQs
1. What is a debt trap?
When you continue to borrow money to pay back current loans rather than using your income to pay them off, you are in a debt trap. You take on more debt to stay a float when your EMI expenses start to surpass what you can afford, and the cycle only gets worse rather than better.
2. Can personal loans create a debt trap?
Yes, if not handled with caution. Because personal loans are unsecured and have higher interest rates than secured loans, the interest load can quickly mount up and put you in a debt trap if you take out several personal loans or don't carefully manage your EMI-to-income ratio.
3. What happens if I miss my personal loan EMI?
Missing an EMI results in late fees, extra interest, and a report to credit bureaus, which can damage your CIBIL score. Repeated defaults can make it more difficult to obtain credit in the future and result in more severe loan default consequences.
4. Is debt consolidation a good option?
If you're managing several high-interest loans or credit card debt, debt consolidation might be helpful because it combines them into a single loan, frequently at a lower interest rate, making EMI administration easier. When your total debt is modest but dispersed over an excessive number of payment dates and rates, it is most helpful.
At Bikesh Finserv, we believe debt isn't the problem; uninformed debt is. If you're planning to take a personal loan or need help structuring your repayment for better financial planning, [explore our personal loan options] or [talk to our advisors] to find a repayment plan that fits your income, not the other way around.