2023 year in review: 7 tell-tale signs of the debt trap you have entangled yourself in this year

As the year draws to an end, it’s essential to assess our financial situation, focusing on debt, which can pose a significant challenge, especially for individuals with fixed incomes. A considerable segment of the populace, particularly those with a fixed income, inevitably faces debt. However, indulging in irresponsible borrowing can result in complications. Numerous individuals still grapple with the weight of expensive home loans, while the desire for immediate gratification has ensnared many, particularly millennials and Gen Z, in a relentless cycle of credit card debt.

Recognizing the perils of irresponsible borrowing and the pitfalls of debt becomes crucial. Though debt is a common reality for many, particularly those with a fixed income, prudent management is essential to prevent succumbing to a detrimental cycle. As the year concludes, it’s essential to be mindful of indicators that highlight your current situation, reminiscent of the potential to fall into a debt trap. Some of these signs include:

Monthly installments over 50% of one’s income

Alluring marketing strategies such as “easy EMIs”, “discounts”, and “sales” can be highly tempting, particularly when combined with the innate desire for immediate gratification. Nevertheless, yielding to their appeal without thoughtful deliberation can undoubtedly steer one onto a perilous journey of debt and financial stress.

This is how these strategies can deceive our perceptions:

• Perceived affordability illusion: Simplifying significant expenses into seemingly manageable monthly payments through easy equated monthly installments (EMIs) generates the illusion of affordability. Yet, the overall loan cost is frequently underestimated, potentially resulting in paying a substantially higher amount than the original price due to accrued interest.
• Fear of Missing Out (FOMO): Time-limited discounts and sales instill a sense of urgency and FOMO, urging us to make impulsive purchases to avoid missing out on a perceived “good deal”. Frequently, we neglect to question whether we genuinely need the item or if its discounted price still surpasses our budget.
• Comparative social influence: Observing others engage in fashionable acquisitions or experiences promoted by promotions may ignite a desire to match the lifestyle of prominent figures like the Ambanis and Tatas in our country. This competitive mentality can prompt excessive spending to uphold a particular image, irrespective of our true financial situation.

Ridiculously high fixed expenses

Your monthly EMIs constitute only a part of the larger fixed obligation puzzle, emphasizing the importance of examining the broader financial landscape to evaluate your fiscal well-being. Rent, society maintenance charges, school fees, and other routine expenditures collectively contribute to your fixed obligations-to-income ratio (FOIR), rendering it a crucial gauge of your debt burden.

Ensuring a favourable FOIR, preferably below 50%, is undeniably essential for financial stability. While this might prove challenging for everyone, particularly those with lower incomes or unavoidable high fixed costs, it remains crucial to aim for a workable ratio.

Exceeding the 70% limit, as you rightly emphasize, is a notable warning sign. It indicates that a substantial part of your income is already allocated to fixed obligations, limiting flexibility and leaving little space for unexpected expenses or saving for the future. Such circumstances can induce financial strain and heighten the risk of falling into a debt trap.

Excessive pursuit of frivolous loans

Consistently relying on loans to meet daily expenses is a significant red flag and should trigger prompt measures to prevent entering a debt spiral. Caution is advised when acquiring debt for routine sustenance. Seeking loans for recurring expenses such as rent and groceries establishes a reliance on debt that can be challenging to break. Accumulating interest charges perpetuate the cycle, making it increasingly difficult to extricate oneself.

The ongoing burden of repayments can be a substantial cause of anxiety and stress. This can have adverse effects on mental well-being and impede the capacity to make prudent financial choices. Are you cognizant of the perpetual risk of losing money to loan repayments? Depending on debt for essential needs renders individuals more prone to financial setbacks such as job loss or unforeseen expenses. This situation can swiftly escalate into a more profound debt crisis.

Taking more loans to consolidate and settle current debts

Generally, borrowing to settle a loan is an unsustainable practice unless it results in substantial interest savings, such as refinancing a high-interest mortgage with a lower one. Numerous borrowers turn to personal loans as a means to consolidate their current debt. Nevertheless, this pattern ensnares them in a relentless cycle of accruing more debt along with additional interest charges, intensifying the challenge of breaking free.

The interest rates on new loans, particularly unsecured ones like credit cards, are frequently higher than those on existing loans, adding additional strain to your finances. Resorting to borrowing to address existing debt signals a loss of control over your financial situation, necessitating immediate actions to restore stability.

Relying too much on credit cards

Employing credit cards for everyday expenses and resorting to borrowing to repay loans are both risky behaviours that can swiftly result in falling into a debt spiral. Credit cards generally carry higher interest rates compared to other forms of loans, such as personal loans or even certain mortgages. This implies that even minor purchases can amass substantial interest charges over time, rendering them considerably more expensive than if you had used cash or debit.

Although paying only the minimum amount due each month may appear enticing, it can be a misleading trap. The minimum payment often addresses only a portion of the accrued interest, allowing the remaining balance to persist and result in even greater interest charges in the future.

Credit cards can effortlessly encourage excessive spending, particularly when utilized for everyday purchases. The ease of swiping a card frequently fosters impulsive buying and a detachment from the actual cost of the items being purchased.

Cash withdrawal using a credit card

Making cash withdrawals via a credit card involves a substantial cash advance fee, usually ranging from 2.5% to 3.5% of the withdrawn amount each month. Over a year, the accrued interest can amount to a considerable 35% to 50%.

Continued loan rejections

Receiving a loan rejection, particularly as a result of a diminishing credit score, can be a concerning indication that demands prompt attention. While a credit score of 750+ is generally considered good for most banks, comprehending the reasons for the rejection and taking proactive measures to enhance your situation is crucial.

In addition to a low credit score, factors such as a high debt-to-income ratio, recent missed payments, or inadequate income can also play a role in loan rejection. A comprehensive understanding of the specific reason is crucial for formulating a targeted action plan.

Being denied a loan can impede access to essential financing for diverse needs such as purchasing a home, launching a business, or handling unforeseen expenses. This situation can impose substantial stress on your financial well-being.

The culture of “Buy Now, Pay Later”, widely embraced by millennials and Gen Z, has the potential to lead to debt if not approached responsibly. Exercising patience and prioritizing necessities over desires is critical. The inclination for immediate gratification and conforming to societal expectations may result in impulsive buying and excessive spending. Recognizing these triggers and cultivating prudent spending habits is crucial. Lastly, a deficiency in financial literacy can contribute to falling into debt traps. Therefore, acquiring knowledge about financial management, budgeting, and responsible borrowing is indispensable.