Tips to Avoid Debt Trap by Being Careful
Debt can be accumulated very fast and can become a matter of worry. There are several financial products and services in a market that offers you a temporary relief from such trouble but many of them are a way to get into a debt trap that can turn your financial conditions even worst. Below are some popular Debt Traps and debt trap recovery guidelines that you should follow to stay away from debt trap and avoid debt:
Debt Trap: Credit Cards
A credit card is a very useful as well as a dangerous tool for us. You can say it as a double edged sword. It can help you in the situation where you have low or no cash but without effective management of credit card usage, you can easily fall into a worse financial situation. Here’s how:
- Late Payment Frees – In an event of failing to pay the payment on/before the due date, you will get a penalty of Late Payment Free. Late payment charges differ from lender to lender too.
- Over-The-Limit Fees – By taking credit card, you agree to pay the over-limit fees if you spend more than the provided limit.
- Cash Advance Fees – Different lenders charges around 2% to 4% on the amount you take from atm using a credit
- Balance Transfer Fees – The provision of transfer balance from one card to another is also available but is chargeable and credit card providers charge somewhere around 5% in this case.
- Annual Fees – Most of the credit cards come with annual fees and that is also a mandatory liability if you are using credit cards.
If you calculate all these charges then you will realize that you are paying a significantly good amount per year on credit card. Other issues related to credit cards are:
- Increased rate for late payments – Few lenders even charge late payment even if you delay for only one day and that comes with the higher interest rate on the account. So if you are normally charged as 9%, it may instantly rise to 29.99%.
- Default rate increases – Some Credit card providers will raise your rate if are found delinquent on any other credit accounts. They regularly monitor your credit report and if you have late then they put the penalty charges on it.
- FAKE “Rewards” Programs – A reward program is where you don’t need to pay anything. If it’s free then choose it else leave it.
- Credit Card Registration Services – These services compile all your credit card and debit card account information and offer facilities against cancellation, replacement or lost/stolen It appears convenient but it comes with a noticeable price tag. Moreover, you can do all those things that are provided by them by yourself for free.
Important Tips for a credit card user/applicant:
Banknomics says, before signing the agreement for a credit card, read it carefully and do your payments on time. It would be better if you do the payments few days before the due date. Do not fall into paying off the minimum amount and try to pay as much as possible to clear the debts that you have created by using a credit card.
Debt Trap: Overdraft Protection / Bounce Protection
Overdraft protection and bounce protection provides for the payment of your checks up to a particular amount and it is useful in an event where you don’t have enough funds in the bank account at the time. You can also tap into it using an ATM if you are strapped for cash. But it’s not free.
- There is an overdraft fee for a bounced cheque or over-limit withdrawal (charges differ from lender to lender)
- Most of these programs give you repayment time of 30 days in which you have to pay all fees including overdraft amount but some give you 15 days and if you don’t repay it on time, they send the account into collection.
- There are few banks who charge on per day basis till the time you repay the overdraft amount.
Important Tip when going for overdraft protection / Bounce Protection:
Learn all the terms and conditions that you are agreeing in case you are choosing an overdraft protection program. Understand the charges, when they will be charged and consequences of not paying them on time. The facility of “Overdraft protection” is an optional facility so you can choose to leave it.
Debt Trap: Mortgage Refinancing
Refinancing looks a tempting option when banks are offering it at a lower rate. This instantly affects your pocket as the monthly payments go down and you will get some extra cash. But it is not the same for everyone. Here are the reasons:
- People with the best credit get lowest rates
- Even if you get a significantly low rate, there will be other costs/considerations like: Do you want to sign up for another 30 years of mortgage payments?
- Also, ask for a detailed breakdown of origination fees and other closing costs related with a refinance. These different fees can be somewhere between 1 lac to 4 lac INR. For a single family home, adding to what you owe.
- Don’t think your house as it’s an ATM machine. The purpose of a 30-year mortgage is to pay off the amount till you retire, to reduce your expenses when your income decreases. Borrowing from your home will keep your house poor.
Debt Trap: Payday Loans
Very expensive in nature, these loans are do provide you funds for a shorter period but with very high-interest rates that can be heavy on your pocket. In this, you write a personal check to a lender for example Rs. 32,200 against the amount borrowed as Rs. 20,000 for 60 days duration. The APR of Payday loans are extremely high and therefore Payday loans are considered as the worst Debt Trap of them all. Most people who apply for one payday loan, go for another loan and then another to repay the first one and get into a debt trap. Banknomics suggest you never go for such financial products as these are too risky. In case you have no other option available, cut down your expenses and save as much to repay the payday loans as soon as possible.
Debt Trap: Car Title Loans
These loans are also called Loan against the car as it is secured by the title to your car and the bank decides the amount and the time duration you are eligible against your car. If you observe it closely, will find the annual interest on such loan goes whopping 250% or higher. Also, the risk of losing your car is there in case you fail to repay the Loan EMI on the due date.
Banknomics suggest you read the documents/agreements thoroughly and self-evaluate your financial situation very clearly that you will be able to repay the loan amount on time.
Debt Trap: Pawnshop Loans
In case of sudden financial requirements, people use to visit pawn shops to take a loan. Such loans are short term loans with a small amount and made to quick fix financial shocks. In case you take this kind of loan, you should understand following points clearly:
- These are short term loans (from one to four months) and secured by property of yours as collateral.
- You can get 50 per cent amount of the item that you are giving as collateral
- The interest rate can range from 2% to 25% per month and the loan repayment can vary from 30 to 60 days
- If you fail to repay the loan amount, your property will be sold.
Debt Trap: Home Equity Loans
It is one of the dangerous loan programs for your financial health. The reasons are:
- It’s a secured loan program that includes your home as collateral. You can get immediate financial relief from this but if you miss any payments, the risk of losing your home is quite high. In reality, some lenders are counting on you missing your payments so they collect on your most expensive asset.
- If you are in a financial misbalance due to overspending, choosing home equity loan can be a big risk as you are accessing more money and with more money comes more problems to a person who can’t control their spending habits.
Debt Trap: Rent to Own
There are some companies that offer you to buy appliances, furniture, computers through a weekly rental payment plan. There are two major issues:
- In case you are doing weekly payments, you are paying more than the market value of the product
- If you miss your payment, the store will take the product back and it does not matter how much you’ve already paid for it
In this online era of eBay, Amazon, Craiglist, furniture, appliances can now all be bought by just a fraction of their retail price. In case you are little short of cash, you can still choose the refurbished or second-hand item that is in working condition.
Debt Trap: Credit Repair
There is no actual service like credit repair and if someone or some company says that they can do it for you then they are fooling you. The fact is that no one needs to pay anyone to repair his or her credit. No one can do anything for you that you can’t do yourself.
- If there are errors in your credit reports, you can correct them by writing letters detailing whatever it is you are contesting.
- The simplest way to improve your credit score is to pay all your outstanding bills on time and at least pay the minimum amount. More than 30 percent of your credit score is based on your credit history of on time payments. In case you have a bad credit history, you should focus on repaying your bills timely and you will see your credit score improving
- You cannot remove a negative information on a credit report if it is correct
Banknomics suggest you not go to any credit repair program. Instead, it’s better to save that amount every month and use it to repay the credit card or other outstanding bills and payments. This will greatly help in improving your credit score. After few months you will have a better civil score if you do it correctly.
Debt Trap: Income Tax Refund Loans
These are short term secured loans from tax-preparation services. They use the income tax amount that you expect from the government. This product includes very high-interest rates and fees, ranging anywhere from 67% to 774%.
In this post, we have learned about a variety of Debt Traps that are available in the form of products and services to help individuals with financial difficulties but can easily turn the situation worst if not taken care properly.
- Credit Cards can be very helpful but must be used with caution. Read the terms and conditions carefully and don’t overuse it
- Overdraft protection programs are good but are paid (remember that). Again Read the T&C carefully and never avoid anything which you don’t understand. Don’t hesitate to discuss it with your service provider.
- Mortgage Refinancing is not meant to be the same level of use to everyone. You can use an Online calculator to find if it is a good choice or not.
- Stay Miles away from high-interest short term loans like Payday Loans, Car Title Loans, Pawnshop Loans, Renting to Own and Income Tax Refund Loans.
- No one needs to pay for actually repairing their credit status. The sooner you pay your outstanding debts; it will start working by improving your credit score that you can also verify by checking your Cibil Report by paying a small fee.
Banknomics suggests you be careful while choosing any of the above-mentioned services and do not take further financial risks to minimize the damage that has already been done. Cut down your unnecessary expenses and save as much as possible to repay all the pending EMI, bills or any running Debts. Be patient and keep paying off your loans, EMI and bills on time and gradually your cibil score will be improved.