How these credit facilities make you fall prey to the debt trap?

Updated: Saturday, December 7, 2013, 10:53 [IST]

How credit facilities make you fall prey to the debt trap?

Life's little surprises always bank on credit facilities. Raj, a 35 year old executive built his dream house which he financed through credit. To meet his new lifestyle requirements, he went on a spending spree adding more electronics to his foray through his credit card. Little he did realize that his debt slowly was snowballing to a huge sum.

Be it your car's sudden overhaul, a mobile upgrade or an unexpected medical expense, credit is the immediate answer for many. But beware that these credit opportunities are just sugar coated debt traps.

How do you know you are slowly falling into the debt trap because of these credit facilities?

Well, there is no one answer to this tricky question. There are some signals which we need to lookout for and get back to track before things go awry. Read on to learn some of the signs of the debt trap.

Falling into the debt trap by exhausting the grace period:

What most of us don't realize that most of the lenders have grace period for making payments? While these additional days do make us feel great initially, the feel good factor doesn't last long. Taking advantage of the grace period can be dangerous. Use these days only for those little mistakes that happen in life. Routine deviation from the actual payment dates is the first sign of danger towards the debt trap.

Take a minute to check yourself. In the last 3 months how many times, you have used the grace period for paying your credit card bills, utility bills, insurance premiums and the like. In case if you miss the grace period also, then you may need to pay hefty amount as penalty or interest. This is how most of us fall into the debt trap unknowingly.

Falling into the debt trap by exercising the credit limit:

Credit cards allow you to spend money you don't currently have, and to repay what you've spent over time instead of all at once. At the offset, when we make small purchases it seems easy to pay them off. The real trouble of the debt trap begins when we start to pay only the minimum charges which barely cover the finance charges. Every small unpaid amount can accumulate over time and when the outstanding balance begins to march north, the ratio of the ‘credit used' to the ‘credit available' goes awry. Refrain from pushing your credit limits too far.

Falling into the debt trap by lagging in payments:

This is the most obvious time for you to ring the alarm and awaken yourself from being caught in the debt trap. What might seem to be acceptable exception for a delayed payment for once slowly turns into a practice, tending towards an insurmountable debt. Adding fuel to the fire is when we are levied late charges and penalties for paying only the minimum amount.

Understand how these signs lead you to the debt trap:

As your debt increases you will soon end up in a debt spiral, which affects your financial position gravely.

Exceed your budget - Paying through plastic money ruins your judgment on how much you are spending and results in overshooting your monthly anticipated outflow.

Worsen your woes - Unplanned and unwise rolling over of credit to meet immediate demands slowly gets you into the vicious circle and worsens your woes.

Unavailable funds in dire needs - Having a bad credit history negatively affects your credit score and impends your chances for a loan approval at the time when you genuinely cash strapped.

Understand the consequences you will face due to this debt trap:

Apart from a bad credit score, the debt trap will impact in the below areas.

Ruins your career - Bad credit is just the tip of the iceberg. Apart from being stressed to pay up your dues, it can tarnish your image in the society.

Affects family relations - It can estrange the relationship due to less available income for family needs.

Draining the financial ability - Overdose and rolling over of credit may limit your repayment ability which may further result in legal battles and litigations.

Basically, it can lead to financial stress of two kinds - drains the relationship between you and your spouse, and in dollar terms, strains your financial ability. The total quality of your life goes havoc.

How can you overcome this habit and avoid the debt trap?

"If you fail to plan, you are planning to fail." Benjamin Franklin. The key to any problem lies in planning. To ensure that the much sought after boon of today's time - credit, does not turn into a bane, you could try:

Expect the unexpected - Create an emergency reserve through an annual or periodic transfer from your income. It helps you meet your sudden car, home or medical expenses.

Accumulate a sum for anticipated annual expenses like school fees, higher education, and insurance. It improves your liquidity position in times of need.

Not biting more than what you can chew. Develop a plan which monitors your spending activity. This helps you to be more aware of your personal finances and avoid lag in monthly payments.

Try to convert your outstanding dues into convenient equated monthly installments.

Bottom line:

Credit is a bouncing ball, the harder you throw, the faster it rebounds.

We cannot even imagine a life without a credit card nowadays. But it's never too late to take steps toward building healthy credit; it clears confusion, adds clarity to your financial planning and results in better financial life for years to come.

The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Director and Chief Financial Planner of Holistic Investment Planners www.holisticinvestment.in a firm that offers Financial Planning and Wealth Management. He can be reached at [email protected]