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Getting mired in loans? Know what to do when you spot signs of a debt trap

Ashish Jha, a self-confessed impulsive spender, started saving and pared expenses to essentials to avoid a debt trap. He borrowed from people at zero interest to bring his credit card bills to nil
Ashish Jha, a young entrepreneur, is a self-confessed compulsive spender. Worse still, he wouldn't mind taking a loan to fulfill his wants. Having faced a debt quagmire early in life that led him to a step into debt trap, Jha is aware of his shortcomings but finds it hard to curb his desire to live on borrowed money.

“I am driven by desire and am an impulsive spender. Quite often, when I don’t have adequate funds, I use my borrowing options and spend generously, thinking I will find adequate repayment options. However, though I try, I often find it hard to service my dues,” says Jha.

Are you one of those with similar debt impulses? If so, you need to do a reality check and take some urgent corrective measures in temperament and financial habits. Entering a debt trap will not only mess up your finances, but could have a serious impact on your personal life as well.

“People who are compulsive borrowers are always under stress and hence their life itself becomes onerous. Also, at a practical level, one loses the freedom to do things one may want to do, as one has been profligate in one's life till then. Many times, these things tell on relationships as well and can even break relationships,” says Suresh Sadagopan, Founder, Ladder7 Financial Advisors.

And also, loan delinquency can mess with your credit score and your ability to access loan in future. Lenders can refuse to give you a loan if your credit score is below a certain level -– for example, a Cibil score below 750. Besides, you may be hounded by the lenders themselves. “In case of default on loan EMIs, banks will make your life difficult to say the least. You might be forced to sell valuable assets such as land and your home at a loss,” warns Sanjiv Singhal, founder and COO, Scripbox.

What leads to a debt trap?

You may not see it coming when it begins, but a missed EMI or an overdue on your credit card can eventually lead you into a debt trap over time. Availing a personal loan to repay your existing credit card loan may sort your problem in the short run, but it isn't a good idea to get away with loan repayments in the long run. Hence, it is important to monitor your monthly expenditure and your income sources. Maintaining a decent balance between both is also important. “A debt trap is triggered by a combination of credit card debt, personal loans, car loans or just borrowing from friends and family and defaulting on payments as per the timelines,” says Singhal.

If you are not there yet, but heading towards a debt trap, here are a few warning signals to look out for:

EMI exceeding 40-45 per cent of your income: As your career graph rises, so does your income. However, that does not mean that you should increase your debt as well. Ideally, you should always try and keep total loans repayments and EMI payments below 30 per cent of your income. However, if you don’t have too many financial responsibilities, then you may exceed this benchmark by up to 5 per cent but not beyond. Any debt repayment beyond 40-45 per cent your monthly income is a sign that you are heading for trouble. “If a big portion of surplus over expenses is going towards servicing EMIs, then one may be heading towards a debt trap,” says Sadagopan.

Default in servicing debt: Paying bills and doing online transactions through credit cards and converting payments into EMIs have now become very common. However, the situation can get worse if you are not able to fulfill the necessary obligations and repayments on time. That is an early sign of an impending debt trap. “You are clearly heading for trap if your debt keeps increasing each month and you struggle to pay just the interest and the minimal principal back,” says Singhal.

Taking a loan to repay existing debt: At times you take a loan just to repay a loan and the chain continues. This may lead to a serious debt trap. “If someone is not even able to service the loans and is borrowing further to service existing loans, he is well into the debt trap,” Sadagopan warns.

Steps to ease debt burden

Financial advisors say change in lifestyle and expenditure patterns could go a long way in avoiding slipping deeper into trouble. “It is a good to examine one's lifestyle, habits and expenses. Lot of problems emanate out of wrong habits. The best way out is to evaluate what one has and pay off with the assets one has. Else, the only other option is family and friends from whom one could borrow to tide over the problem and pay them off as soon as one can,” Sadagopan says.

If things get worse, Sadagopan says you should look at liquidating assets to repay debt. “Many times, people have assets (including financial assets) which they do not want to liquidate. They get a false sense of security by keeping the assets intact. It may be a good idea to liquidate them and pay off the loan. If such assets are not there or for some reason cannot be liquidated, it may be a good idea to take money from family/friends to pay off loans as the last option,” he says.

Singhal advises taking a hard look at expenses and ensuring they are less than your earnings. “Download your last six months' bank statement and credit card statement and calculate your total expenses. You must learn to distinguish between needs and wants. Work towards systematically reducing you borrowings. Step down on your lifestyle a bit,” he says.

Name: Ashish Jha
Age: 30
Family status: Married with one child (4 years old)

Do you think you are an impulsive spender or you had to spend due to need?
I would agree I am driven by desire and am an impulsive spender. Quite often when I don’t have adequate funds I use my borrowing options and spend generously thinking I will find adequate repayment options. However, though I try, I often find it hard to service my dues.

What are the types of loans you took?
I have availed personal loans, loans on credit card and being an entrepreneur, business loans. I always make aggressive use of my credit options, whether they are  credit cards or other loans. To be honest, most of my expenditure is unplanned and after a point it’s difficult to pay. Hence I look for more time to repay or negotiate with the lender.

How much debt did you have compared to salary?
At one point, I had debt that was multiple times my income. Since I had immediate expenditure and not much in saved funds, debt was the only option. Since I had a good credit record at that time and it helped me avail loans and funds.

What steps did you take to avoid walking into a debt trap?
Since I was paying heavy interest on the debts, it was pounding on my pocket, I made a plan where I started saving and reduced my expenses to essentials. I also borrowed from people without interest charges to pay my credit card bills and bring them to nil. I also tried to reduce multiple debts to one only, which made it easier for me payback and track.

What lessons have you learnt?
Since we have convenient and flexible credit cards and loan options, we often become careless and spend beyond our limits. There is a pile-up over time. In order to control one debt, we take another and the chain goes on. Also, one should plan one’s expenses and debts requirements very carefully. One should never use debt options generously on luxury or wants. If you are taking any debt options make sure that you have certain savings/ back-up to pay the debts in time or at least you manage to pay on time else things get worse.

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