An Introduction to Debt Trap

At the beginning of their financial life, none of the Americans think that they are going to end up in a debt trap. But sadly many of them do! Therefore it is essential to understand how the debt trap builds up.
It is called a trap, because very few see it coming. Only the trained eye can
know what decisions to make and how to avoid the trap.

Rule #1: Many Small Debts Add Up To a Huge Debt

Typically, people will not take a huge debt and find
themselves in financial difficulty. Usually debt starts with making small
purchases on the credit cards. These purchases are usually impulsive and not
thought through by the buyers. The psychology behind the purchase is that there
are enough resources to pay this small debt off when need arises.

However, what follows is that many small payments combine.
Soon, most of your monthly income goes towards making monthly payments. You
find yourself short of making regular household expenditures. Thus you begin to
take even more debt.

Rule #2: Bad Gets Worse

When it comes to personal debt bad gets worse with time. Most lenders will charge you less interest and fees till the time you are making your payments. However, when you do get into debt and are finding it difficult to make your payments, your credit rating takes a hit. This is when the interest rates on your loans will go up and with them the payments. Hence,
if you do some damage, the system does the rest!

Rule#3: Compounding

Compound interest grows exponentially. It is for this reason that debt grows faster than you can pay it off. It is important to understand how compound interest works. 1 percentage point difference in compound interest rates can make a lot of difference.

Thus, to avoid the debt trap understand compound interest, do not make impulsive purchases and don.

Prioritizing Your Debt

All debts are not equal. They are equal in the fact that each one of them is lethal if unmanaged. However, they can harm you in different ways. It is not uncommon to see two people with the exact same debt pay very different amounts in interest over the lifetime of the debt. Hence prioritization is important. It needs careful thinking to figure the best way
out. Once you are in the debt trap.

Interest: The first thing to do when you have multiple debts is to ensure that you list them by interest rate. The one with the highest interest rates should be at the top. Next thing to consider is tenure. For instance you could be paying a 17% per annum interest on a credit card purchase. However, if the interest amount is only $200 and you have bigger problems like a $1000 interest on your car loan, then the car loan should be the obvious priority!

Fees: Creditors realize that many customers view interest rates only before they take a loan. Hence to make the interest rate appear lower, they disguise the costs in the form of fees and charges. Ensure that you have a good look at the fees.

Lowest Overall Amount: Lastly, you must pay off one debt at a time. This means paying minimum amount due on all other debts, while you finish the one which has the most interest amount and fees attached to it. This can reduce the total amount paid and time taken by as much as 10%-15%. However, there are numerous permutations and combinations that are possible when you have multiple debts.

Taking the help of a professional might be a good idea. It is better to find out the best way to pay off your debt. Panicking or blindly making fixed monthly payments may not be the best option.

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