Whenever you take a loan, you must repay the principal amount and interest earned as per your repayment schedule. For example, if your loan against property tenure is ten years, then every month for the next ten years you are required to pay an EMI to clear your debt. Inability to repay the loan as required leads to a debt trap.
Here are a few indicators of a debt trap:
- EMIs exceeds 50% of monthly income: If your total EMIs are higher than half of your monthly income, you are headed towards or already in a debt trap. You should consider paying at least some of your debts using your savings. It is important as too many EMIs will become difficult to service in times of emergencies. If the EMIs consist of many small EMIs going towards various purchases, you are probably falling prey to “easy EMI” offers. Make sure you rectify this situation as soon as possible.
- FOIR of over 70%: Ideally, your fixed obligations to income ratio or FOIR should not be higher than 50%. Loan against property eligibility typically includes a maximum FOIR of 65%. If your FOIR is over 70%, you have little money left to meet any ad-hoc expenses that may come up in any given month.
- Loan for regular expenses: You should never take on a loan to meet your regular expenses. Remember, the loan amount comes at a cost – the interest rate. Typically, you should only borrow money when you need to fulfil a need in your life. Your regular expenses do not generate a return. For example, if you take on a property mortgage loan for a business expense – it should either be to meet an immediate expense or to improve business profitability in the long run.
- Loan to repay another loan: The only reason to refinance a loan should be a lower interest rate. For example, property mortgage loan typically attracts a lower interest rate than a personal loan. If you have a bunch of personal loans, you could consolidate them through a property mortgage loan and save on the interest paid. But if you have to take on a loan to repay a previous loan, you are deep in a debt trap and should stop looking for another loan.
- Withdrawing cash using your credit card: One of the costliest debts that you can take on is – withdrawing cash using your credit card to pay an EMI. It is something you would only do as a last resort. If you have to withdraw cash using your credit card, you are probably in a debt trap.
- Failing to clear your credit card dues: If you default on your credit card bill, it means you have taken on more debt than you can service. If this is the case, you should stop taking any more debts and draw a plan on how you would come out of the debt trap you are in.
If you have fallen into a death trap, you should look for a debt consolidation option to become repay your loan easily and become debt-free.