Most of us are living on borrowed money. In the US, as per Experian, credit card debt is $829 billion and personal loan debt stands at $305 billion. Retail credit card debt stands at $90 billion. According to TradingEconomics, in China, household debt stood at 55.20 percent of GDP in the fourth quarter of 2019.
Everyone would like to have zero debt, but circumstances prompt them to borrow for their education, their marriage, their children’s education and so on. To make life full and fun, expenses are made on vacations, restaurant meals, theme park visits, shopping, hospital visits and the movies. The income of an individual cannot often support all these expenses which sometimes happens concurrently. Most households end up being heavily leveraged, and ensnared in a debt trap.
The journey into a debt trap is usually a slow and painless one, until one day, you realise you have way too much debt. How do you recognise you are in a debt trap?
Your monthly equated installments (EMI) are more than 50% of your total income. You have high fixed expenses and you borrow for regular expenses such as rent or the children’s school fees. You borrow frequently to meet your needs. This could be taking hand loans or personal loans to go on trips or house maintenance. People who are knee high in loans tend to take an overdraft or cash withdrawals from their credit cards. This is dangerous, because you are taking money with higher interest to pay a loan with lower interest. If you are unable to pay utility bills or the minimum amount on your credit card balance, it is a sure sign you are in a debt trap. Some serious lifestyle changes along with financial re-engineering is in order.
Good financial practices include budgeting within your income, saving up for big ticket purchases, using your credit card sparingly, not having more than two loans running concurrently and investing wisely. Unfortunately, this is not always practiced, sometimes because of poor financial habits and sometimes because of circumstances. Today, many people are losing jobs or facing pay cuts due to reduced consumer demand because of the pandemic caused by Covid-19. There are simply fewer jobs and more budgetary cuts. Expenses however remain unchanged and in many cases expenses within the household have increased.
Fortunately, there are many ways in which we can dig ourselves out of the debt holes we find ourselves in.
Consolidate your debts
Before you start repaying a penny, prepare an excel sheet of your debts. Consolidate them with their corresponding interest rates. Note down their due dates as well, there is no need to pay a late fine in addition to the exorbitant interest rates you have to pay for them. Make provisions like giving the mandate for ECS or automated electronic clearing services with your bank. Do ensure you have sufficient funds in your account.
Make the minimum payment on your credit card
You may not be in a position to make a lump sum payment on your credit card. No matter. Keep paying the minimum balance. You can save small amounts of money for three to four months and add this to your minimum balance payment towards the principal every quarter. It may seem like a drop in the ocean but it will add up.
Pay your fixed expenses
As soon as you get your salary or income for the month, pay your fixed expenses like utility and rent. Keep aside money for food, before you think of splurging your money on luxuries, like that new coat, to join the four others in the closet.
Once you pay fixed expenses, pay minimum balance or more on your credit card and your EMIs. This gives you little scope to waste money.
It is a great practice to have an emergency fund, but very often most of us have none. Our credit cards are our emergency funds! It is a good practice to keep aside some money for an emergency fund. It could be as low as $500, but just a little kept aside in a checking amount that is liquid and easy to access.
Use your savings to reduce debt
Apart from your emergency fund, if you have money lying in fixed deposits earning a low rate of interest, use it to pay it towards your debt with the highest rate of interest. If your debt is very high, savings in the bank do not have much meaning.
You can invest in mutual funds, stocks or gold even in a systematic manner. This helps you spread out your risk. Many jewellers offer a scheme where you can save a fixed amount every month for say a year. It may not yield a high interest but it allows for you to buy gold at the end of the year. You can alternatively also invest in ETFs or Exchange Traded Funds. You can invest in a Systematic Income Plan or SIP through a 401(K) account, trading account or a mutual fund. These are passive investments and need to be looked at from time to time.
Stop the money bleed
You should be aware where you are bleeding money and where you can delay purchases. This can be done when you look at the cause of your expenses. Sometimes it can be many small streams on products/ subscriptions you do not use like a library membership or a subscription software. Impromptu purchases can be another source. Sometimes the same service may have good but cheaper providers. In this case you must shift. This exercise can be done every month or once in two months. Keeping a close eye on your expenses can be quite revealing and helpful in undoing some financial mistakes.
Protect yourself from sudden changes
Invest in both life and health insurance to protect your family from any untoward health crisis. You can also take insurance on your home loan and your car.
Look at multiple sources of Income
If finances are too tight, you may consider a part-time gig in addition to a regular job. This can help ease up your debts and make more money available to you. Do consider asking your boss for a raise too!
Ask family for help
You can borrow money from your family if they are ready to lend a hand. Usually family loans have 0% interest. Use this help to reduce your debt burden. Make sure you pay them back.
Check your credit score and monitor your credit report
Your credit-worthiness is determined by your credit score. You can avail the services of companies such as Borrowell to find your credit score. You can also get their credit report services from them. They help provide customized tips to understand and improve your credit. Their recommendation engine analyzes your credit profile and makes professional financial product recommendations.
Good financial health like good health can be maintained with good habits. Sometimes despite all precautions and care, we are assailed by poor health. In such circumstances we seek help from experts and take greater care of ourselves. Similarly, when we are faced with poor financial health we can seek expert advice, change some of the things we do and keep working towards better financial health.