A debt trap is when a loan or debt is nearly impossible to repay due to high interest rates or deceptive lending practices. This can lead to a cycle of debt for the borrower that’s difficult to get out of.
What Is a Debt Trap?
Have some clumsy financial decisions brought you one step closer to a debt trap? Don’t worry; it can happen to anyone. No matter how experienced you are with finances, it’s always wise to stay informed on debt traps. Falling into a debt trap is unpleasant, but avoidable, and even if you are already experiencing the issue—it has a solution.
A debt trap is a situation that may lead borrowers into a cycle of re-borrowing or rolling over their loan payments (paying to have your loan due date extended) because they are unable to afford the scheduled payments on the principal of the loan.
These traps are usually caused by high interest rates and short loan terms. Debt traps occur when the borrower cannot pay off the loan, so he or she only pays the interest (or a part of it), to extend the term of the loan.
What Can Cause a Debt Trap?
The five most common factors that can put you into this situation include short loan repayment terms, high interest, lump-sum repayments, loan rollover, and poor financial management.
Interest rates depend on your creditworthiness, the type of loan, and the general health of the economy. You should consider these factors before choosing to take out a loan. For example, choosing a lump-sum repayment can come with certain risks. No matter how small your loan is, even if you think your wage can cover it, lump-sum repayments can let you slip into debt traps.
Checking the lender from whom you are planning to get a loan is critically important; there are financial institutions that may ask for high interest and offer unfair loan terms so they can profit more. That’s not the only thing to look out for. There are certain types of loans that may increase your chances of slipping into debt traps.
Credit cards are a line of credit, and they can be risky. A line of credit means that you do not have a certain amount of money given as a lump sum, but a pool of cash instead. The available credit has a certain maximum amount, and you can spend the money below the maximum limit at your will. But you’ll need to repay that amount within a certain time. Otherwise, interest will accumulate until you clear your balance. You may also have to pay late payment fees, over-credit-limit fees, and balance transfer fees.
A title loan is a secured cash loan where borrowers use their car title as collateral. The loan amount is based on the value of the car. Title loans are short-term loans and have a lump-sum payment, meaning that borrowers need to pay the borrowed amount (principal) plus all the costs in a certain period. Most lenders have a 30-day term, but some offer longer repayment terms and an option to pay in installments. Title loans can also be risky. If the borrowers don’t repay their title loan on time, the lender may repossess their vehicle.
How Can a Borrower Avoid a Debt Trap?
Evaluate your financial situation before taking out these types of loans. Credit cards, for example, can get you into a rollover cycle if used without planning. Also, before opting for any loan, think thoroughly about your needs. Think about the term, the principal, and the amount of interest. Consider all aspects of your present and future finances to conclude if borrowing is necessary. Take into account the following things:
- Put the pen to the paper. Figure out how much money you need for what you want. Then choose the right type of financial support. If it’s not something necessary, it may be smarter to skip the purchase. Otherwise, you might consider getting a loan from a friend or look for lenders who offer personal loans with fair interest rates and favorable terms.
- Try to cut some of your expenses. Analyze how you spend your money and which activities are costlier than necessary. Then, plan how you will minimize funds spent on less important things.
- Create an emergency fund for risky situations. Pledging as little as $20 a month will help you in the long run. Only one year’s worth of saving will get $240 into your emergency fund.
What if You’re Already in a Debt Trap?
If you’ve found yourself in this trap, follow the advice above. Identify the financial issues to solve it successfully. Prioritize your needs and concentrate on resolving the most urgent mishaps, one by one. Consider trying to change your lifestyle, too.
Remember, there isn’t an issue in the world of financing that cannot be solved. And yes, it can be hard to cut things out of our life or make big changes, but it’s the simplest way of getting yourself out of financial trouble.
Payday loans, title loans, and credit cards are helpful when used sensibly. Choosing the right personal loan can help you avoid the possibility of falling into a debt trap. If you’re taking out a loan to help your finances, check out the personal loans made or arranged by CreditNinja. Start your application today to get the financial support you deserve.