Life’s little surprises always bank on credit facilities. Raj, a 35 year-old executive built his dream house which he financed through credit. To meet his new lifestyle requirements, he went on a spending spree adding more electronics to his foray through his credit card. Little he did realize that his debt slowly was snowballing to a huge sum.
Be it your car’s sudden overhaul, a mobile upgrade or an unexpected medical expense, credit is the immediate answer for many. But beware that these credit opportunities are just sugar-coated debt traps.
Table of Contents
- How do you know you are slowly falling into the debt trap because of these credit facilities?
- Falling into the debt trap by exhausting the grace period
- Falling into the debt trap by exercising the credit limit
- Falling into the debt trap by lagging in payments
- Falling into the debt trap by the flat rate
- Falling into the debt trap of advance EMIs
- Falling into the debt trap laid by the loan agent
- Falling into the debt trap because of fake promise
- Falling into the debt trap because of scams
- Understand how these signs lead you to the debt trap
- How can you overcome this habit and avoid the debt trap?
- Bottom line
How do you know you are slowly falling into the debt trap because of these credit facilities?
Well, there is no one answer to this tricky question. There are some signals which we need to lookout for and get back to the track before things go awry. Read on to learn some of the signs of the debt trap.
Falling into the debt trap by exhausting the grace period
What most of us don’t realize that most of the lenders have a grace period for making payments? While these additional days do make us feel great initially, the feel-good factor doesn’t last long. Taking advantage of the grace period can be dangerous. Use these days only for those little mistakes that happen in life. Routine deviation from the actual payment dates is the first sign of danger towards the debt trap.
Take a minute to check yourself. In the last 3 months how many times, you have used the grace period for paying your credit card bills, utility bills, insurance premiums, and the like. In case if you miss the grace period also, then you may need to pay a hefty amount as penalty or interest. This is how most of us fall into the debt trap unknowingly.
Falling into the debt trap by exercising the credit limit
Credit cards allow you to spend money you don’t currently have, and to repay what you’ve spent over time instead of all at once. At the offset, when we make small purchases it seems easy to pay them off. The real trouble of the debt trap begins when we start to pay only the minimum charges which barely cover the finance charges. Every small unpaid amount can accumulate over time and when the outstanding balance begins to march north, the ratio of the ‘credit used’ to the ‘credit available’ goes awry. Refrain from pushing your credit limits too far.
Falling into the debt trap by lagging in payments
This is the most obvious time for you to ring the alarm and awaken yourself from being caught in the debt trap. What might seem to be an acceptable exception for delayed payment for once slowly turns into a practice, tending towards an insurmountable debt. Adding fuel to the fire is when we are levied late charges and penalties for paying only the minimum amount.
Falling into the debt trap by the flat rate
The flat rate always makes people fall for it. Flat rates seem cheap but only a few customers realize that it does no good for loans with EMIs. In the flat interest rate, the interest rate is calculated on the full amount of the loan during the entire tenure. It does not consider the monthly EMIs paid, which gradually reduces the principal amount.
As EMI reduces the principal outstanding, these loans should be assessed on the reducing interest rate. The next is the loan processing fees. It is usually 1 to 2% of the loan amount but this can effectively increase the rate of the loan.
Falling into the debt trap of advance EMIs
Here the customerrs are asked to pay two EMIs in advance. Eg: If you take a loan of Rs.6 lacs at 10% for 5 years, your EMI comes to Rs.12,748. If you pay two EMIs in advance, the net loan disbursed reduces to Rs.5.74 lacs, still, you will be charged for the 6 lacs.
They have ready answers if the customers question them. They distract the customer by pointing to him a mistake in the form, ask for an additional document, or talk about some other features. This is why they make the loan application process very fast. They don’t let customers read and understand the clauses in the loan document. The terms and conditions are anyway given in small font and they are asked to sign quickly.
RBI has asked banks not to charge foreclosure charges on floating-rate loans. The foreclosure charges would be mentioned in the loan agreement but you would have missed reading it if you were in a hurry to sign it.
Falling into the debt trap laid by the loan agent
When a customer takes a loan, the loan agent earns a commission. But they earn even more when they sell an insurance policy. And so, they sell single premium term plans along with home loans. The insurance policy covers him and pays off the loan if something unexpected happens to him. The premium payable gets added to the loan amount. These policies are structured in a way that the death benefit comes down as he pays the loan.
A regular term plan with annual premium payments (though costlier) is better compared to a single premium insurance cover linked to a loan. If the loan is foreclosed or transferred to another lender, the insurance contract ends.
Selling insurance with a home loan is legal. However, you need not necessarily buy this type of insurance. A bank cannot compel you to buy insurance from it.
Falling into the debt trap because of fake promise
Loan agents get higher commissions if they sell costlier products. For example, car salesmen get higher rewards if they manage to sell a bigger car. They try hard to convince a customer to spend more. They would compliment you about your good taste and lifestyle, just to hit your ego and make you spend more (whether you require it or not).
Verbal promises made to you at the time of sale have no meaning once the transaction is completed. You will come to know later that the extended warranty comes with terms and conditions applied.
Falling into the debt trap because of scams
These fraudsters call you and offer you loans with very attractive interest rates. Once you take the loan, they charge a processing fee or file charges. Once you pay that, they will ask you for more money on some other pretext. This will go on until you stop paying and ask them to disburse the loan and then they would disappear.
Another type of scam is where they say 0% interest on loans. There is obviously a hidden cost. They just want you to buy an insurance policy from them and they keep it as collateral (This is a lie because insurance without a paid-up value is nothing). The idea is to sell you the insurance policy. Once you buy it, they act like processing the loan. As soon as the 30 days free look period to return the insurance policy is over, they will stop taking your calls.
Understand how these signs lead you to the debt trap
As your debt increases you will soon end up in a debt spiral, which affects your financial position gravely.
- Exceed your budget – Paying through plastic money ruins your judgment on how much you are spending and results in overshooting your monthly anticipated outflow.
- Worsen your woes – Unplanned and unwise rolling over of credit to meet immediate demands slowly gets you into the vicious circle and worsens your woes.
- Unavailable funds in dire needs – Having a bad credit history negatively affects your credit score and impends your chances for loan approval at the time when you genuinely cash strapped.
Understand the consequences you will face due to this debt trap:
Apart from a bad credit score, the debt trap will impact in the below areas.
- Ruins your career – Bad credit is just the tip of the iceberg. Apart from being stressed to pay up your dues, it can tarnish your image in the society.
- Affects family relations – It can estrange the relationship due to less available income for family needs.
- Draining the financial ability – Overdose and rolling over of credit may limit your repayment ability which may further result in legal battles and litigations.
Basically, it can lead to the financial stress of two kinds – drains the relationship between you and your spouse, and in dollar terms, strains your financial ability. The total quality of your life goes havoc.
How can you overcome this habit and avoid the debt trap?
“If you fail to plan, you are planning to fail.” Benjamin Franklin. The key to any problem lies in planning. To ensure that the much sought after boon of today’s time – credit, does not turn into a bane, you could try:
- Expect the unexpected – Create an emergency reserve through an annual or periodic transfer from your income. It helps you meet your sudden car, home, or medical expenses.
- Accumulate a sum for anticipated annual expenses like school fees, higher education, and insurance. It improves your liquidity position in times of need.
- Not biting more than what you can chew. Develop a plan which monitors your spending activity. This helps you to be more aware of your personal finances and avoid lag in monthly payments.
- Try to convert your outstanding dues into convenient equated monthly installments.
Credit is a bouncing ball, the harder you throw, the faster it rebounds.
We cannot even imagine a life without a credit card nowadays. But it’s never too late to take steps toward building healthy credit; it clears confusion, adds clarity to your financial planning and results in better financial life for years to come.
Take an effort to get out of the debt trap right now. The longer you put it off, the harder it will be to get out of debt and to pay everything off. The hard work is worth it, and when you are debt-free, you will have more money in the monthly budget. A debt pay-off plan helps a person become debt-free. Similarly, a complete and comprehensive financial plan will help you achieve financial freedom. If you want to understand our 360-degree financial planning process, we offer