Escaping The Debt Trap

High income levels, increasing consumer choices, easy credit availability, low interest rates,. has made going in for debt to finance the ever-increasing desires and aspirations, a common phenomenon.

However, in the euphoria you may have forgotten one of the earliest lessons of financial prudence i.e. to live within one’s means. Should you not heed to this advice, you could find yourselves falling into a debt-trap.

You are aware of the trauma of being in a debt-trap. Apart from affecting your financial health, it also badly affects your personal life. Therefore, it would be wise to take appropriate steps before your creditor seizes your car or house; before you have to face any public embarrassment; before the problem becomes too serious.

As you look at ways to reduce or eliminate debt, first understand the difference between a ‘good’ debt and a ‘bad’ debt. A good debt builds ‘useful assets’; bad one finances consumption and luxuries. The idea is to eliminate the ‘bad’ debt first.

Say No to a new debt
First promise yourself not to take on any new debt – especially the ‘bad’ kind of debt. Stop all purchases on credit. If you have the cash – buy or else simply forget it. Ideally, you should cancel all your credit cards and switch over to debit cards. This will prevent you from building any fresh liabilities. And before committing to a new ‘good’ debt do a thorough analysis of your financial situation.

Debt is like a cancer. First you need to stop it from spreading. Then only you can take further steps to reduce and eliminate it completely.

Prioritize repayment
List all your borrowings - credit cards, personal loans, house mortgages, motor vehicle finance, loans from friends & relatives etc. - and their interest charges.

Give priority to debts with the highest interest burden. These will be your credit card outstanding and personal loans. They carry very high interest rates. Also these loans usually finance consumption – a vacation, a dinner, dresses, gifts etc.

Therefore, these are the first to go. Moreover, these loans are not very large and you may be able to pay them off immediately or in a relatively short period of time.

Thereafter, you can look at loans from your friends and relatives. Automobile finance is the next target.

Home mortgages build useful assets. Also the interest rates on these are usually low. Moreover, whether you pay rent or EMI, the cash outflow could be more-or-less the same. So tackling home mortgage comes in the end.

Balance your budget
Decide to follow your forefathers’ mantra of living within our means. Your budget becomes the starting point. You have to match your income and your expenses. Generally income is not easy to change, especially in the short run. Therefore, you should start by reducing your expenses.

The expenses can be broadly classified as essentials (food, electricity, school fees, telephone, traveling etc.) and non-essentials (weekend dinners in restaurants, movies, new dresses etc.). The non-essential expenses can be completely cut or reduced substantially till you become debt-free. Even amongst the essentials, there is a lot of scope for cheaper options without any compromises.

These efforts should enable you to save some money to start paying off your debts. And as your debts go down, so will your interest costs, and month after month you will find more and more surplus in your hand.

Talk to your creditors
It generally pays to have an honest dialogue with your lenders on any significant issues. Say you took an adjustable rate mortgage for your home a few years back. The interest rates have been rising since then, adding to your interest burden. Therefore, go and talk to your bank. They might consider a switch to a fixed-rate mortgage. You may have to pay some fees for the switch, but overall you may still save some money.

Or say you want to prepay a debt, but the agreement does not have such provision. You can negotiate with your creditor and work out a deal.

Sometimes you may experience some difficulty in timely repayment of your dues. Instead of avoiding, the better option may be to talk to the bank and explain your situation. And also the plan of action as to how you propose to get out of your financial difficulties. More often than not the bank will appreciate this and may reschedule your debt.

Working towards becoming debt-free could be a tough ride. But it is a short-term pain to long-term peace and prosperity. You owe it to your family and children. The earlier you start the better it is.

If you'd like to find out more about how you can escape the debt trap, contact on 1300 724 307 today for a free consultation.

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