Borrowing, if done smartly, can make you financially stronger. You can borrow to create assets such as a residential property or a business. But debt also needs to be managed smartly. It is your legal, financial, and moral obligation to repay what you owe your lenders. If you aren’t paying attention to debt management, your debts may spiral out of control, dragging you into a deep debt spiral that could harm you financially and keep you perpetually in debt. Here are signs that you may be spinning into a debt trap.
Not Enough Savings
Everyone must try to save at least 10-20% of their monthly incomes. If you spend everything you earn, you have no savings and therefore you have no avenue for investments and wealth creation. Spending all your income means that your expenditure is out of control. At this rate, your expenditure will soon exceed your income. Once this happens, you’ll need to borrow to meet your expenses.
Borrowing For Daily Consumption & Lifestyle
To the highest extent possible, you should meet your regular, fixed expenses as well as your lifestyle needs through your income alone. Need new clothes? Pay for them from your salary? Want a foreign holiday? Pay for it from your savings. If you’re unable to do so, and if you’re funding your consumption and lifestyle with borrowed money, you’re mismanaging your finances.
EMIs More Than 50% Of Your Income
It’s not unusual to see people servicing multiple loans at the same time. Often, people have concurrent education and car loans, or home and car loans, or a personal loan along with credit card debt. But EMIs need to be kept at manageable levels. The ideal level would be 30-40% of your monthly income. If you stretch it further, you’re taking risks. Over this manageable level, your income will be stretched, your savings would be lower, and in an emergency you may find yourself short of cash.
Frequently Missed EMIs & Bill Payments
If you have frequently missed EMIs and bill payments, you need to rethink how you manage money. Missed EMIs lead to a damaged credit score and possibility of default. You need to be more disciplined with your payments. You can start by automating your bill payments and creating an ECS mandate with your bank to automatically pay your EMIs. This way, your dues are out of your way first thing in the month, and the rest of your money can be directed towards expenditure, savings and investments.
Unable To Apply For Fresh Loans
When you apply for any new loan or credit card, the lender examines your credit history to assess how much debt you’re currently in and how you’ve managed to pay your dues. If you’re under a lot of debt and also have a patchy repayment history, your credit score would take a hit. With a decline in your creditworthiness, it would be difficult for you to apply for new lines of credit in any form.
Credit Card Debt Out Of Control
A credit card offers you the financial freedom to spend now and pay later. But what’s borrowed must be repaid on time. Credit card debt is the most expensive form of debt, with annualized interest rates exceeding 50% in some cases. In comparison, a home loan costs around 8-9% right now. Therefore, avoid spending more than 20-30% of your card limit, and always try to repay your dues in the interest free period, because credit card debt is expensive.
Using Credit Card For Cash Withdrawals
Credit cards normally allow you an interest-free period. However, if you use your credit card to withdraw cash, you must pay interest from the first day. Avoid using your credit card at the ATM. That is an option you should exercise only in the direst need.
Having A Poor Credit Score
Have you checked your credit score lately? Just go to Google and search for “free credit report” and get yours for free in 5 minutes. Your credit report is a summary of how you’ve managed loans and credit card. If your score is poor (under 700), it may be because you’ve been irregular with your repayments. You may need a loan in the future to buy a home or a vehicle. So take the shock of having a poor credit score and use it to improve your financial standing. Take it upwards of 800 with disciplined credit card use and timely EMI payments.
Borrowing To Repay Existing Debts
When this happens, you’re well and truly in a debt trap. Borrowing to repay existing loans is a financially toxic situation to be in, and you need to examine how you’ve got to this stage. You must get out of this situation soon. Prioritise your debts and repay the most expensive ones first.
Loans and credit cards can help you fulfill your life goals such as buying a home or car. However, undisciplined use of borrowed money could lead you into a financial nightmare, so always be thoughtful with debt management.
The writer is CEO, BankBazaar.com