Though borrowing money is highly beneficial to people in a number of situations, it often gets a bad
rap—and a big part of that has to do with debt traps. For those who don’t know, a debt trap is a
situation in which a borrower falls easily into a cycle of re-borrowing or rolling over their loan payments.
Several things can cause someone to fall into a debt trap, but the two most common reasons are: (1)
they have a hard time paying interest (a percentage of the principal amount of debt that the lender
charges for financial services), or (2) they don’t have enough time to pay all the money back.
Therefore, the borrower is on the short end of the stick on their arrangement with their
lender—subjected to difficult or impossible terms, as well as prey to predatory lending practices.
That’s where the value of a credible lending institution and fair loan terms come in: they allow you to
make the most of your borrowed money and eventually guide you to a debt-free situation. General
knowledge holds that a bank loan is the safest way to borrow money, and that loan programs from
banks will yield the easiest terms to keep up with.
On your part, you can make the most of your chosen loan type and avoid debt traps by doing the
following:
1. Make sure you understand the purpose of taking out a loan. Sometimes borrowers get so
caught up in the rush of making their payments that they forget the rationale of paying off a
loan: the intention is to make headway on paying off the principal amount, and not just the
interest per month. If it’s only the interest that’s being paid off and not a large enough part of
the principal, the biggest chunk of debt will remain in the borrower’s hands—and they will
remain trapped in that cycle for a long time.
2. Choose a lending institution and a type of loan that will offer interest rates within your means.
As far as borrowing money is concerned, it’s often better to choose a bank loan with longer
loaning terms that a short-term fix like pawning an asset.
In the latter situation, the amount of money you can borrow is highly dependent on the value of your collateral (and the values of assets can fluctuate so easily). With former, on the other hand, you will be part of a safe and reliable system of lending, and you will be paying on predictable terms.
There are different types of bank loans (such as personal loans, home loans, and auto loans)
with different amortizing structures, or fixed schemes of payment. After you’ve compared
between banks and loan types, you should settle on an arrangement that is a practical fit for
your personal circumstances, your income situation, and your family life.
3. Watch out for the three precursors to a debt trap: short repayment terms, lump sum
requirements, and loan rollover. These three problems are considered the “three horsemen” of
financial ruin by debt trap, and a bad loan arrangement may feature all of them. Short
repayment terms may force you to scramble on your repayments in a way that will deplete your savings.
On the other hand, lump sum payment requirements will demand that you fork over
more cash than you are capable of parting with at a given time.
Lastly, loan rollover prevents you from recovering from your debt and going back to a clean slate as soon as possible.
That said, if any lending arrangement shows signs of any of these three, walk away and apply for
another one.
4. Strive to be in good credit. Having poor credit can also lead you to a debt trap; banks usually
issue less favorable loan terms and higher interest rates for those who have a bad history with
borrowed money. You will want to prove the opposite to your bank: that you keep your credit
card balance low, that you pay your bills on time, and that you’d successfully cleared all
outstanding debts before you applied for a bank loan.
5. Be conscientious about fulfilling your loan terms. Lastly, once you’ve secured the loan of your
choice, you can avoid the self-imposed debt traps of late fees and penalties by following all of
the loan’s conditions. Don’t be remiss on your payments, pay early if you can, and ask your bank
for advice if you are experiencing any trouble related to your loan repayment.
Debt will accumulate easily if you aren’t part of a reasonable agreement—or if you do not follow
through on managing the money wisely. That’s why it pays to be wise about your loan
arrangements—and to be very careful about avoiding debt traps!
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