Several decades ago, you can only afford what you want if you have the money to spend on it directly from your bank account. You’d definitely have to save money to achieve your financial goals in those days. However, things are quite different today.
With the availability of credit cards, loans, and EMI schemes, money is relatively easy to access by almost everyone. But sadly, this easy access to credit has created a pathway that leads millions of people into a debt trap.
Debt trap, one of the most challenging financial difficulties people experience, is something you need to be fully aware of. Hence, this post will properly answer the question, what is debt trap? Also, you would learn some of the best-known actionable steps to help you get out of debt trap and avoid it for good.
What Is Debt Trap?
A debt trap is a situation where the amount of money you owe becomes too much for you to pay off. This often happens when you spend beyond your means and fail to protect your finances.
How Does A Debt Trap Work?
Debt trap is usually not something planned or foreseen. It occurs due to careless spending and the inability to pay off one’s debts one at a time. When you accumulate debts rather than reduce or pay them off, you are literally building a debt trap around yourself.
Common Causes Of Debt Trap
Knowing what is debt trap is essential. But more importantly, you should be acquainted with the common causes of debt trap. Here are 5 main reasons why people are entrapped in debt:
- Loss Of Income Or Low Income
If you are not earning enough money, the next available means of survival could be credit. Continuing with this method will inevitably lead to a debt trap because you can’t keep taking from a source without replenishing it. If your income level is quite low, it’s best you find a reliable way to boost your cash flow instead of using credit cards to sort out your expenses.
Thankfully, there are so many amazing side hustles from home you can use to complement your main income stream. Pick one that suits you, and stick with it until you experience some growth in your finances.
- Education Costs
Every year, tens of thousands of students in the United States are bagging college degrees on student loans. This is not entirely bad since most people can always pay off student loans by getting a lucrative job or operating a profitable business.
However, some people spend more than a decade paying off their education costs, which could lead to a debt trap if not handled properly. Over the years, student loans have proven to be one of the common causes of debt trap.
- Extravagant Lifestyle
Most of the time, the price of enjoying an extravagant lifestyle is a debt trap. Even rich folks, especially the business-minded individuals, understand the risk of living extravagantly. Whether you are rich or not, avoiding a lifestyle beyond your means is an intelligent way to secure your finances.
Spending beyond your control may prove that you have a ton of money, but it’s one of the surest ways to find yourself in a debt trap. The moment you notice you are beginning to spend your hard-earned money outrageously, consider it as one of the debt trap signs and make necessary adjustments immediately.
- Depending On Credit Cards
Credit can prove helpful while facing some financial hurdles, but that doesn’t change the fact that it has its downsides. Debt trap is one of the reasons why you shouldn’t rely on credit cards. As a matter of fact, it’s best to avoid using credit cards entirely and focus on what you can honestly afford. This way, you can prevent debt and have a better plan for your money.
Nonetheless, if you keep using credit cards, make sure you clear your balance in time. Don’t pile up credit card debt since that would lead to a debt trap.
- Bad Budgeting
Failing to have a plan for your money is another common reason you might end up in a debt trap. This is why you must always budget your money properly. Find a feasible budgeting strategy that allows you to organize your expenses and spend wisely. If the pay-yourself-first budget works well for you, then you should stick with it. If it doesn’t work for you, find a different budgeting strategy.
Notwithstanding, the goal is to ensure that your money is well-budgeted, so you can stay in control of your finances. Without a good budget, you will likely incur debt due to impulse purchases and misplaced priorities.
6 Ways To Avoid A Debt Trap
Preventing debt trap is important if you don’t want to be crippled financially. Here are 6 strategies that will help you avoid debt trap:
1. Prioritize You Needs
Understanding the clear difference between your needs and your wants is the first step to learning how to avoid debt trap.
Analyze your current financial situation to know whether you are actually improving your finances or sliding down the rabbit hole of debt. Filter out your essential expenses from the non-essentials, and focus spending money on the things that are important to your sustainability.
For example, instead of eating out all the time, learn to prepare your meals at home since it’s cheaper.
On the other hand, develop good financial habits that will encourage you to improve your finances. The kind of habits you exhibit towards your finances will determine if you will succeed financially or not. Here are 10 better money habits you should start practicing right away if you want the best for your finances.
2. Invest
You will never have to bother yourself about what is debt trap if you start investing wisely henceforth. Investing in high-return schemes such as equity, mutual funds, and even bank deposits will shield you from debts and emergencies.
In a situation where you have to take loans to sort out a financial need, your investments can be used instead. More importantly, investment is one of the crucial steps to building wealth, and you can increase your net worth remarkably through the right investments.
3. Stop Incurring Debt
When figuring out how to avoid getting into debt trap, stop taking on more debt.
Taking personal loans or using credit cards when you have an outstanding debt is a very terrible mistake. Even if you are taking more loans to pay off your existing debt, it’s still not a safe decision because you will keep incurring more debt. It’s best to pay off your debt using only your income stream, even if it’s going to take time.
4. Build An Emergency Fund
Building an emergency fund is one of the best strategies to avoid debt. Create a separate fund strictly for dealing with financial emergencies. You never know when you’d fall sick, lose your job, or have to face another covid-19 pandemic. This is why you must be financially prepared by building an emergency fund that can conveniently cover 3 to 6 months of your living expenses.
A bank savings account is a good option to build your emergency fund. But if you want to enjoy good returns on your savings, you can park your emergency fund in a chit fund to guarantee better returns and quick liquidity.
Moreover, if you want to fully understand how to build an emergency fund, here’s an article that explains how anyone can successfully set up an emergency fund in 7 simple steps.
5. Budget Your Income
Knowing how to build a budget is one of the essential tips to avoid debt trap. When spending your paycheck without a budget, you won’t be able to make the most of your money. Besides, impulse buying will begin to creep in, leading to debt. Budgeting your money will help you to save, identify your basic expenses, and it also helps you to determine where your money goes.
When you know how your money is being spent, you can easily keep track of your expenses and make better decisions while spending your finances. It’s high time you start budgeting your income if you haven’t been doing so.
6. Protect Yourself Against Economic Shocks
Economic shock is a situation where you suddenly realize that you don’t have the financial means to maintain your current lifestyle.
For example, if you lose your job or your business unexpectedly fails, you won’t be able to meet your everyday needs anymore. This can easily lead to debt trap because you might be tempted to rely on credit to cover your expenses.
Knowing what is debt trap and averting its consequences is crucial. But sadly, you may never be able to avoid debt trap if you fail to first secure yourself financially. Building an emergency fund, acquiring instance policies, and investing your money wisely are some of the common methods for ensuring financial security and preventing yourself from experiencing economic shocks.
How To Come Out Of Your Debt Trap – 5 Helpful Tips
As much as you have an understanding of what is debt trap, you should also know how one can recover from it. Here are 5 feasible tips to help you come out of a debt trap:
1. Examine Your Debt Trap
This is the point you need to start with if you want to learn how to recover from debt trap. As someone who is already in a debt trap, it means you have multiple debts to pay off, not just a single credit balance. This should compel you to take stock of your debts. Organize every detail concerning what you owe since it would give you headway in dealing with the debt.
You can start by making a simple list of the various debts you owe and their interest rates, EMIs, and tenures. This will help you determine the particular debt you need to pay off first.
2. Avoid Additional Loans
Taking on more debt while you are yet to be debt-free will only worsen your situation. In fact, if you truly know what is debt trap, you will avoid this at all cost.
Ideally, you aren’t expected to apply for any loan while struggling to clear an outstanding debt. You will be staining your finances by doing that. Hence, it’s best you pay off one debt at a time every month. Usually, this would take time, especially if you aren’t earning much money. But if you are bent on figuring out how to come out of debt trap, you would trust the process.
3. Be Protected From Disease, Disability & Damages
Having insurance to protect you and your family from disease, disability, or even damages is a great way to overcome debt trap for good.
For example, a loan protection policy will ensure that even in your death, your family’s needs and your loans will be taken care of. Your family won’t be subjected to incurring debt in order to get by.
Similarly, insuring your health and properties will make it impossible to be in a debt trap if you are critically ill, involved in an accident, or lose certain properties to disasters. Insurance against these risks is definitely one of the smart ways to get out of debt trap.
4. Increase Your Income
Since low income is one of the things that lead to debt trap, increasing your income is a smart move.
By increasing the amount of money you earn in a month, you will reduce the pressure that comes from paying off debt. Besides, you can speed up the repayment a little bit by making extra payments. If you are clueless about what you can do to make extra money, you can pick up freelance jobs relevant to your skillet.
Freelancing is one of the easiest ways to generate extra cash to complement your main income stream. Surprisingly, freelancing has become a full-time hustle for some folks.
However, if you want to explore various ways to make money, check out this post that reveals 15 proven ways to $100 a day.
5. Leverage Your Investments To Repay Debt
When you know what is debt trap and how it can drastically affect your finances, you won’t look down on investment opportunities.
Investing your money in a profitable venture will not only make you financially stable, but it will help you repay debt easily. You must understand the power of multiplying money. That’s how millionaires are mostly made. You don’t have to keep living paycheck to paycheck without having solid financial backing from another source of income.
Buy assets and preserve them for at least a year to enjoy a reasonable return. If you can’t buy assets, bank deposits and chit funds are other amazing investment options for growing wealth.
Final Thoughts On How To Avoid Debt Trap
Having understood what is debt trap and how to deal with it, you should be encouraged to take charge of your finances and avoid being trapped in debt. If you rely on credit to solve urgent financial issues, ensure you repay on time. Don’t allow your debt to linger and pile up to prevent yourself from spending more money on high-interest rates.
Moreover, knowing the smart ways to avoid debt trap is key. If you duly practice the strategies examined in this post, you should be able to prevent yourself from incurring too much debt.
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