Debt traps have many consequences, including credit score, financial, social, and psychological effects. An expensive loan doesn’t necessarily lead to a debt trap. You can repay a huge loan without much hassle if your income is sufficient. Failure to pay EMIs (equated monthly installments) on time, interest on the outstanding loan keeps rising and may involve late repayment penalties, leading to your overall debt inflating.
In such a case, you may take fresh loans to repay the existing ones, getting you trapped in debt. However, you can avoid this situation with debt management and repayment strategies. This article outlines seven smart ways to get out of the debt trap.
- Determine the causes of your debt trap
Identifying why you’re in a debt trap is the first step to finding tips to get out. If your EMI exceeds half of your income and your fixed expenses are over 70% of your income, you’re slowly getting debt-trapped. Having many loans and exhausting your credit card limit are other signs you’re getting into a debt trap. If you can’t make monthly savings, it could be due to your fixed expenses, including debt. Once you identify the cause of your debt trap, make a plan and find ways to address that area.
- Consider debt consolidation
Debt consolidation involves taking one loan to repay another or multiple existing loans/ debts. You can consolidate an old debt into a new one in various ways, including taking a credit card with a higher credit limit, a new personal loan, or a home equity loan to repay the smaller debts using that new loan. You can consolidate your debt using secured or unsecured loans. A secured loan is supported by an asset, such as your car or home, which acts as loan collateral. However, unsecured loans don’t need security and are harder to get. Also, their interest rates tend to be higher and qualifying amounts lower.
Debt consolidation can help you repay your debt sooner, primarily if it accrues less interest than the other individual debts would. It can also lower your monthly payment and improve your credit score, streamlining your finances. This means debt consolidation would be a perfect option if you want to get out of a title loan or any other loan.
- Start budgeting
When trying to get out of a debt trap, strictly following a budget can help you attain your objectives sooner. Budgeting lets you understand where your earnings go every month, helping you spot spending patterns you need to change and areas to cut back. It also enables you to determine how much money you can safely direct to debt repayment. With a budget, you can build an emergency fund and ensure it remains intact as you clear your debts. This cushions you when unforeseen expenses arise, keeping you from getting into more debt.
With a budget, you can determine the extra amount to direct to your debt every month and set up autopay or automatic transfers. To create a budget to repay debt fast, assess your monthly income and list all your expenses, including variable and fixed. Group the expenses into necessities, debt payments/ savings, and non-essentials. This will help you allocate and adjust your spending accordingly.
- Leverage the snowball debt repayment method
The debt snowball is a debt repayment strategy where you prioritize the smallest debts followed by the second smallest, and then the next in that order. You then continue the repayment process until your debts are fully repaid. This debt repayment method is simple to implement because you don’t need to compare APRs (annual percentage rates) for various obligations.
Clearing one debt at a time motivates you to pay off the rest. Since the snowball debt repayment technique prioritizes balances and not APRs, you may spend more on interest over time. Also, repaying one debt at a time means you’ll take longer to get out of debt.
- Try the debt avalanche debt repayment technique
The debt avalanche is an accelerated debt payment technique where you allocate sufficient funds to make the minimum repayment on every debt source and channel the remaining repayment money to the debt whose interest rate is the highest. Once you fully repay the debt with the most interest, the extra repayment money goes to the loan with the second highest interest rate. This cycle continues until each debt is cleared.
The best part about the debt avalanche payment method is that it lowers the interest amount you part with in the long run. It also cuts the time you need to escape a debt trap, but only if you maintain repayment consistency, leading to less interest accumulating. To succeed with this debt repayment strategy, you must stay consistent.
- Find ways to increase your income
Finding more ways to make money is among the best ways to get out of a debt trap sooner. Start by asking for a salary raise, and if this doesn’t work, look for a better-paying job. If your schedule allows it, find a part-time job to improve your income, especially if the first two options don’t materialize immediately.
Starting a side hustle, hosting a garage sale, and finding ways to slash your expenses and save more funds to pay off your debts. You may also consider earning from your hobbies, including cooking, writing, blogging, photography, gardening, music, DIY crafts, and more. Creating a passive income, such as stock market investing, rental properties, and earning royalties, can help you make more money.
- Build an emergency fund
An emergency fund caters to sudden expenses, helping you cope with unemployment and keeping you from high-interest loans in unexpected situations. However, creating or maintaining this fund when in debt can be challenging. Obligations that help you pay for appreciating assets are good. While you should make a minimum repayment on your debts, prioritizing an emergency fund instead of directing extra money to good debts, such as mortgages, is more important.
However, you shouldn’t skip your monthly debt repayment to grow or build your emergency fund because this can lead to late fee charges, a drop in your credit score, your debt being sent to collections, and the seizing of your property.
A debt trap can significantly impact your financial, social, and mental health. Nonetheless, using these tips can help you get out of the debt trap, leading to debt relief.