Debt Trap: What to look out for if you have a credit card?

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How can you avoid getting into a debt trap?

The easiest way to make your loan search (and application) simpler and faster is to maintain a high CIBIL Score. Learn about the most common debt traps, and how to steer clear of it so that it does not affect your credit health negatively.

What are the signs that indicate that you are or may be getting in to a debt trap?

When you are spending beyond your means
When you are paying your bills late and constantly missing payment deadlines
When you have exhausted existing loan options available
When you can’t do without a credit card
When you have not made any investments in a while

How can you avoid getting into a debt trap?

Today most of the urban population uses a Credit Card. It is a brilliant way to manage your money provided you pay your credit card bill on time. Since you are buying more credit period, this means your savings continue to earn at least minimal interest rate (if it is lying with the bank) while you continue to spend. But do take a note of the points below:

Read the fine print:

Before availing any new credit, read the terms and conditions. Taking Credit Card as an example, let’s discuss a few eye-openers:
- Interest free credit period-
  
  You may be under impression that you have 30-35 days of interest free credit, but don’t forget that this period starts from the first day of the billing cycle and not from the date of purchase (unless otherwise specified by your lender). You can best utilize this by making most of your purchases at the start of your billing cycle and thereby effectively using the “interest-free period” to stay out of the debt trap.
- Interest Cycle-
  
  In most cases, interest rate is charged from the date of purchase and not from the payment due date in the event of any default or payment of minimum amount due. Let’s look at an example:
  - Amit buys a LED TV for Rs 50,000 on 1st January, and a washing machine on 15th January for 12,000. The due date is 15th February. He misses this deadline. So now the interest calculation which can be as much as 36-45% p.a will be levied along with late payment charges.
  - So how is the interest rate calculated? It is generally calculated from the date of purchase and not from the due date or bill date. This changes everything! Amit now would be paying interest for 45 days on the TV and 30 days for the washing machine purchase. So even though you may think that you missed your payment by a day or a week, your interest liability is much more!
- Cumulative Interest-
  
  When you are revolving your money i.e., just paying the minimum due, you continue to accumulate interest charges from the first date of purchase. Whenever a payment is being made it is being offset against the first purchase. Once that is adjusted then it moves to the next purchase. In short, it follows the FIFO method. For example, If your current credit card bill is Rs 10,000 and assuming you are not spending further on the card and paying Rs 500 monthly, then it will take you as much as 3 years to pay off the entire amount. For every 100 you have spent, you will pay back Rs 175!
Spend only on what you need:

You may have read this before but it does not get simpler than this. Follow a simple exercise for a month- track ALL your expenses. Note it down on your phone or at home. When you do this, you will realize where your money is going. Then curtail on the things that you don’t need.

Also all this effects your CIBIL Score. Not only does your payment history gets affected in case of default but also your current balance increases, indicating higher debt.