What has to happen before you think you are in a debt trap? Does default of your EMI payments or credit card payments count as a debt trap? Or is there a less critical situation which can also be termed a debt trap?
What about when you do not make your credit card payments in full and have somehow been able to keep your account regular by making minimum payments? If this is a temporary blip because of an emergency and you are confident of getting back on track in a month or two, it is acceptable. However, if you are paying “Minimum Payment Due” for six months in a row, you have to be honest to yourself. Your situation is about to get worse.
So, you have debt trouble not only when you are unable to make EMI payments or credit card payments on time. That is a strong form of debt crisis. You are in a debt trap even when you are somehow making debt payments on time but have little to invest after meeting these commitments and other monthly living expenses. This can seriously harm your long term financial health.
Your debt payments and monthly expenses leave you hardly anything to invest/save. These EMIs will go on for another 5-10 years. You cannot wait for so long to start some investing for your other financial goals. How do you get out of this debt trap? Well, there is just one way of getting out of this trouble: Reduce your EMI burden. And there are four ways of reducing the EMI burden. Increase your income, decrease your expenses, reduce your debt or reduce the cost of your debt. Let’s look at some of steps you can take to get out of your debt troubles.
Increase Your Income
Increasing the income is something that may not exactly in your control beyond a point. If possible, pick up a better paying job. Or you can pick up some freelance work that can provide some extra cash every month. However, this approach may have limitations, at least in the short term.
Decrease Your Expenses
Squeeze your expenses. Cut down heavily on discretionary expenses. At first, it might appear difficult. I have a solution. Take out a print of your credit card and bank statements for the last two months and show them to your wife, a trusted friend or a family member. Let them play devil’s advocate. You will soon find out dinner outings every week are not all that compulsory and can be easily avoided. Cutting down on expenses is a relatively easier task than increasing your income. These savings can be used to reduce debt. If nothing more, you will have some free cash flow to invest.
Repay debt aggressively. Rather than having Rs 5 lacs in a fixed deposit, break that FD and use the funds to repay debt. I am not even averse to recommend selling off your stock/MF holdings to repay debt if things have gotten or are about to go out of control. Selling off your long term assets to dispose off your debt liabilities is not exactly desirable. However, you shouldn’t have got into this situation in the first place. Now that you have gotten into one, you should make tackling this problem your topmost priority.
Sale of an asset. You may have a bike that you have not used for a long time parked in your garage. Or an iPad that you bought a year back but hardly every use. Well, you have been saving the bike for your next trip to Ladakh. The trip hasn’t happened in the last four years and is unlikely to happen anytime soon. If you are struggling with debt, this might just be the time to put such possessions to use. Put them on the block. There are so many online sites such as Quikr and Olx where you can easily find buyers for such pre-owned items. And yes, use the sale proceeds to reduce debt. Idle gold in your portfolio can be sold too. Technically, any asset that yields less than the cost of your loan can be sold to set off the debt.
Reduce the Cost of Debt
Talk to your friends/family to lend you money for a short term. This can be tricky. This can give you a temporary reprieve. Use the borrowed funds to repay high cost debt. However, if you fail to repay your friends/family, this may harm your relationship too. Hence, you have to be extra sure that, given this short term support, you will be able to get back on track.
Refinance your loan. The idea is simple. Replace the high cost debt with low cost debt. Lower interest means lower EMI. EMI for Rs 10 lacs loan for 3 years will be Rs 33,214 at 12% p.a. and Rs. 36,152 at 18% p.a. So, if your credit card debt is troubling you, you can take up a personal loan at a lower cost and use it to repay your credit card debt. A personal loan at 12-18% per annum is much less expensive than credit card debt (which can go as high as 40-45% p.a.).
Top-up your home loan to repay other high cost loans. Home loan is typically the least expensive debt. A top-up loan, though not as cheap as a home loan, may be available at a much lower interest rate as compared to personal loans or credit card debt. You need to have a home loan before you opt for a top-up loan. Find out more about top-up home loans here.
Take a credit card balance transfer. Transfer your credit card balance on one card to another. Typically, credit card companies lure you to transfer outstanding amount on other cards to them at relaxed repayment terms. Relaxed repayment terms may be in the form of lower interest rates or affordable EMI options. Banks typically offer multiple balance transfer schemes. The choice of scheme shall depend on your cash flow position.
Do not wait till your debt problems turn into a full blown crisis. Look for the signs of trouble. If your EMIs take away a major chunk of your salary and you are finding it difficult to save anything after accounting for regular expenses, you are looking at some serious trouble ahead. You need to get aggressive in handling this situation before it goes out of hand. You need to make EMIs affordable.
Take every possible step including cutting down of discretionary expenses, refinancing the loan at lower rates and even sale of certain assets to reduce your EMI burden.