People fall into debt traps for several reasons. One of the key reasons is financial illiteracy. People are often not aware of the repercussions of not repaying a loan. It seems easy to fulfil their dreams by taking a loan, but repaying a debt can be a long-term commitment that needs financial stamina and discipline.
It is also a legal and moral obligation to repay one’s debts, which is why defaulting on your debts comes with punishments such as having to surrender securities associated with the debt, or having to take a massive dent in your credit history, which would make it difficult for you to ever buy a loan again. Another reason is a miscalculation of the repayment capacity.
Spend within your means
When we speak of discipline, it is important to—as a habit—spend within your means. If you can ordinarily fund a purchase with your savings, you should avoid taking a loan or reduce the size of the loan you need. If you go for the second option, you’ll be better placed to repay your debts and not have to borrow more or borrow beyond your capacity.
Plan your short, medium and long term expenses and also consider how you could meet them with your income which may keep growing at a certain rate. Budget for the expenses. See if you can fix any leaks or potential bad habits. Especially avoid the habit of spending more than your income and set aside as much as you can for savings.
If you maintain a healthy contingency fund, you can easily repay your EMIs in case you find yourself in a short-term crunch. The size of a contingency fund must take into account your loan EMIs and all other fixed expenses such as
insurance premiums, utility bills, tuition fees, etc. Such a fund should be parked in a liquid investment instrument such as a bank deposit or a liquid mutual fund so that it can be used as and when required.
Control credit card use
Do not use it where you can use a debit card or cash. Try to spend no more than 30% of your available credit limit. Regularly going above this limit could negatively impact your credit score. Always repay your card bills in full and don’t settle for the minimum payment option. Credit card debt, with annualised interest rates touching 35%, is very expensive and can easily drag you into debt.
If you invest as per you short, medium and long-term goal and also borrow money according to the goals at various stages in life, there’s very little chance your debt will spiral out of control. Regular investment could inculcate the habit of buying things out of your own funds, therefore dissuading you from getting into debt.
The writer is CEO, BankBazaar.com