10 ways to prevent a Debt Trap or come out of one

Before I lay down the rules, I confess that no single point or remedy below claim to be a solution. But yes, a combination of these steps can be used to eradicate a debt problem. This is an exhaustive list, hence you may not relate to some steps. Ignore those but do give them a reading as situations change and you must be aware rather than feel sorry later. So please go through the steps carefully and apply them to your own life or share them with people whom you know are facing a debt trap.

Debt Trap

Image courtesy of ratch0013 / FreeDigitalPhotos.net

10 tips top avoid Debt Trap

  1. The first rule is to use cash only. By cash I mean your own cash, which you have earned or invested. This does not mean that you should not go in for a loan at all. Stick to two basic loans- home and auto loans.
  2. Never go overboard. In fact, do save a little money regularly instead of spending all the money you earn. Saving does not mean that you save to bail yourself out one day. It should be a self-induced disciplined activity.
  3. In case you feel that debt has started surfacing, try to save as much as possible. Start saving at least 50% of your income. So, for example, if you see you marriage date has been fixed and you have to take a loan to finance it, start saving immediately. The cash will help you minimize the loan.
  4. Always be aware of your liabilities. Your mind should be clear on how much you owe to the world around you. It has been seen that ignorance about how much you owe leads to debt augmentation. So, even though you rely on the bank to calculate the your monthly balance on your credit card, after each swipe for a purchase you should have a fair idea of how much your credit card bill will be on the due date. It is always useful to make a list of people whom from whom you have borrowed money and you should be aware of the terms and condition of the loans.
  5. Try to live with one credit card only. Or at max two. More than this will cause wastage and confusion. One of my bosses used to boast that he has 11 credit cards with a total credit limit of Rs18 lakh. He was very proud of this fact and used to say to me “I carry 18 lakh in my pocket”. I did not respond to him that time, as I myself was not so aware of credit card debts. However, if he meets me today, I would simply tell him, “Now a days, banks are running short of secured places to keep their cash, so they have converted it into plastic and have kept it with the general public. In case it is robbed, the public can be blamed”.
  6. Before reading further, immediately cut the extra credit cards and discontinue them by paying the dues and informing your bank that you won’t require them. Your bank may not like the idea and may try to woo you back with some freebees like an enhanced limit. Do not fall into the trap. Walk out of it by committing yourself to one or just two credit cards.
  7. If you have issues while settling the dues on the credit cards that you wish to discontinue, speak to the issuer. Request them to convert the balance into EMIs and destroy the card the moment you clear all the equated payments. If you have a large number of cards with small payments pending on each, you may transfer the balances to one and then settle it.
  8. You credit card bill must be settled every month with the present month’s earnings or salary. The balance should not spill over to the next month. So, instead of paying the minimum dues partially, pay the entire amount due.
  9. Never pay off credit card dues from an emergency fund. As discussed, it should be paid from that very month’s salary. In case it is exceeding your capacity to repay from your salary, instead of using emergency cash, resort to EMIs to repay. If EMIs are costly, pay from the emergency fund and replenish it with the EMIs and then don’t dip into it again.
  10. Never allocate more than 20% to EMIs of one loan. If you are taking a housing loan, the EMI should not be more than 20% of your income. (you may say its not possible, you may be right but…) Normally, housing loans are the biggest type of loan a person undertakes, so if you are able to tame this one, your chances of becoming a winner are bright.

For more personal finance tips, check my book “Financial Life Planning”.

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{ 8 comments… add one }
  • Kirti April 15, 2014, 12:36 PM

    Good information very useful. It’s so easy so fall into the debt trap!

  • Asha April 15, 2014, 12:39 PM

    Hi Hemant
    I have been religiously reading your articles on “The Financial Literates” and it has given me a great understanding especially on insurance, mutual funds and bank deposits. The focus on Indian market scenario is pretty useful.

    It will be really great if you can share an article on how to set a right portfolio, (based on the age) that will guide the investors on the right mix of equities, dividends etc. Please also share on a weekly basis on SIP investments on mutual funds (based on the fund performance). This will give us a guideline on choosing the mutual funds .

  • Aravinda Lochanan April 15, 2014, 2:27 PM

    True, I’ve come across a few, juggling with credit cards, withdrawing cash from one and paying another etc…completely absurd. The trap is such that, it becomes a way of living…somewhere they loose their integrity as well.

    The very thought of living within means is completely absent. As long as one finds a match for the wants with credit, it seems to be the easiest choice.

    Just like we have credit monitoring in banks after the loan is given, I wish, there was something similar in credit card business as well.

    • Siva April 15, 2014, 7:25 PM

      Dear Hemanth,

      As usual wonderful and educative article.. Thanks a lot for your simple but effective suggestions which help us to plan finances in a better way..

      I found your articles which surfing something on the net accidentally (Good one though 🙂 ) and I’m following your articles for the past 2 yrs and learnt a lot from your articles and implemented few in day to day financial planning..

      Once again, than you very much!!!

      Regards,
      Siva… 🙂

  • Anil Kumar Kapila April 16, 2014, 7:55 AM

    Hi Hemant
    I am not in favour of auto loan.Young people are crazy about big cars. It is better to buy a small car without taking a loan. Although i have many credit cards I have not used any for many years.

  • b viswanatha varma April 18, 2014, 8:56 PM

    Dear Mr Hemant
    thanks for the useful site dedicated for financial awareness/ education.

    regards
    varma

  • vs April 29, 2014, 8:45 PM

    Irresponsible use of credit card is certainly harmful, but I am surprised people don’t use the benefits of the card in meaningful ways. If you have the advantage of cash backs, discounts, and award points, why not make appropriate use of them instead of feeling proud of not using the card at all…wouldn’t make any economic sense to me.

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