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When a borrower takes out a number of loans, or rolls over a loan because they cannot afford repayments, they are caught in a debt trap. High interest rates and short loan terms can cause this to happen.

What is a Debt Trap?

When a person borrows, the repayment structure is set to pay back the principle and the interest. A debt trap is when the borrower can only afford the interest repayments and nothing towards the principal. This loan will never be paid off.

Can You Get Out of The Trap?

Escaping from debt after being caught in a debt trap can be very difficult. Many people who get themselves into mountains of debt spend many years, sometimes their whole adult lives, working to get back out of debt. High debt levels have a big impact on your life and affect your ability to enjoy the type of life you would like.

Some of the resultant effects of being in a debt trap are:

  • Unable to pay bills
  • Unable to make repayments on credit debts
  • Missing mortgage payments

All of these can lead to a damaged credit rating and even the loss of your home.

How not to fall into a debt trap?

It can be extremely difficult getting out of debt, but it’s best to focus on trying to clear the debts rather than getting into more debt to help tide things over. This is short-term thinking. Many people that are already in debt continue to take out loans and credit to solve immediate financial problems. It works great in the short term but in the long-term, you are getting deeper into debt.

Consolidation – Yes or No?

Consolidating existing loans is one mistake people in debt make, then instead of working hard to kill that loan consolidation amount they simply run up additional debts. This cycle continues as they take out another consolidation loan after a while. The process can go on for years and that means the debt trap just gets tighter as it takes years or decades for the borrower to get out of debt. A vicious cycle of debts and consolidation loans!

Credit Reliance

It’s a fact that living without any credit in this world is difficult, we all take out a loan or have a credit card at some point in our lives but becoming reliant on credit is where the danger lies. Personal characteristics like willpower and determination need to be exercised when it comes to taking out finance. Don’t overstretch your budget and take out loans for the sake of it rather than because you really need the money.

Credit Card Use

Another way in which many people become caught in the debt trap is through the use of credit cards and store cards. While these cards can be useful and very convenient when shopping, it’s important that you make the minimum repayments each month on the cards. Otherwise, this is a sure way to be caught in this debt trap for years. Use the card when you have to, but repay in big chunks so that the debt balance is cleared as soon as possible. Mind you, repaying the full amount each month is a far better idea rather than paying interest.

Credit Card Debt

Cards can be very helpful when you need to buy something and you don’t have the cash. Here’s how it happens. You reach your credit limit and you are only able to pay the minimum amount each month. You might as well throw your money away. All you are paying is the interest and account fees. The balance remains the same. The overdue fees for a missed payment will put you even further behind.

Solution

You want out of this self-destructive spiral? Then understand what you have to do to stay out of debt with your existing credit cards. Use discipline and list acceptable things to charge such as emergency car repairs or unexpected medical expenses. Do not use your card to pay other bills. That’s just compounding the problem. Do not use your card to pay for nights out, gifts, clothing or jewelry. Use the card when only absolutely necessary. Set your repayment budget so that you can afford to pay off the balance.

Payday Loans

Payday Loans are great for quick cash, but if, for some reason, you cannot repay the loan on your next payday, then interest and fees start making it harder to finish off the loan.

Solution

Make sure you had a valid reason for taking out the loan. Bite the bullet and allow the full repayment to be taken out of your account. You have to practice some discipline to live a little more cheaply during the next pay period so you avoid having to take out another payday loan. Rolling over Payday loans is the biggest trap of all.

Loan Consolidation

This was mentioned earlier. You take all your smaller loans and bundle them into a consolidation loan. That means you have just one loan repayment a month, a better interest rate, and usually a lower total repayment amount.

Solution

Make a daily, weekly, monthly budget and stick to it, because if you don’t you will start using your credit card or applying for more loans. Eventually, this will see you back to applying for another consolidation loan even before the current one is paid off.

Home Equity Loan

You use the equity you have in your home as collateral to borrow money. But keep in mind that missed payments on this type of loan can cost you your house.

Solution

If you use the home equity loan as a consolidation loan, that makes more sense than using the money to spend on a holiday or a new car. A mortgage interest rate is usually low, so if used wisely, and you discipline yourself not to take out any more loans, it will work. Remember, the value of your home is also increasing every year.

In the USA, the debt level is nothing short of horrendous. However, applying some discipline and curbing your spending habits, waiting until you have saved the money to buy something, these can all help put you and your family in a far better financial position than the majority of the population.

References and Sources

1. Maryalene LaPonsie (2018). 10 Unexpected Debt Traps – and How to Avoid Them. Money.Usnews.Com. Available at https://money.usnews.com/money/personal-finance/debt/articles/2018-09-21/10-unexpected-debt-traps-and-how-to-avoid-them

2. Debt Trap. Businessdictionary.Com. Available at http://www.businessdictionary.com/definition/Debt-Trap.html

3. Don Hofstrand. Types of Term Loan Payment Schedules. Extension.Iastate.Edu. Available at https://www.extension.iastate.edu/agdm/wholefarm/html/c5-93.html

4. Bill Fay. Predatory Lending: Laws & Unfair Credit Practices. Debt.Org. Available at https://www.debt.org/credit/predatory-lending/

5. (2018). Self-Employed Face High Debt Levels, Says Charity. Bbc.Com. Available at https://www.bbc.com/news/business-46072906

6. (2015). High Debt Drags Down the Economy. Crfb.Org. Available at http://www.crfb.org/blogs/high-debt-drags-down-economy-0

7. Frances Coppola (2018). Everything You’ve Been Told About Government Debt Is Wrong. Forbes.Com. Available at https://www.forbes.com/sites/francescoppola/2018/04/17/everything-youve-been-told-about-government-debt-is-wrong/#7953586e314f

8. Dealing with Debt. Usa.Gov. Available at https://www.usa.gov/debt

9. What is Loan Consolidation? Studentloans.Gov. Available at https://studentloans.gov/myDirectLoan/launchConsolidation.action

10. Government Debt Consolidation Programs. Consumercredit.Com. Available at https://www.consumercredit.com/government-debt-consolidation-programs