THE DEBT CYCLE: HOW IT WORKS AND WAYS TO MANAGE IT

What is a Debt Cycle?

When there is shortage of money, loans and credit cards come in handy. But few people realize that this over dependence on loans can push them in a debt cycle, which can prove to be damaging in the long run. People trapped in a debt cycle start seeing it as a way of life.

Simply put, debt cycle is a habit of continual borrowing that leads to more debt, increasing costs, and eventually a default. When things are bought on loans, you end up paying the interest money along with the actual price of the commodity.

Suppose you already have debts on home, car, jewellery, holiday trips, etc and the interest costs itself eat up a large chunk of the monthly expense. Now if there is an unfortunate event like an illness or you are sacked, chances are another loan will be taken to pay off the interest of existing loans. Basically the cycle goes on from one debt to another causing a lot of stress.

Main reasons of developing a debt

1. Spending more than earning: Well, cut your coat according to your cloth goes the old adage. It means people shouldn’t spend more than they earn because debt surfaces when we go around swiping that credit card for everything we want.

2. Inefficient financial planning: Bigger financial problems are a result of smaller financial mistakes committed on a daily basis. From shopping without a list to not remembering to pay bills on time lead to rise in expenditure which gradually surpasses the income forcing a person to settle them via debts.

3. Not keeping a track of expenses: When people fail to realize what is eating up their savings and take corrective measures to reduce them, the debt cycle continues. For some, making a list of weekly or monthly expenditure seems like too much work compared to the convenience of using credit cards like a magic wand but they don't realize the money they are losing.

4. Lack of savings: The ‘earn and burn’ generation often doesn’t heed to their elders’ advice of saving money as a contingency plan. Courtesy the ‘you only live once’ (YOLO) concept and instant gratification, they shop for things right away without saving money for future where a big or small financial crisis may hit them hard.

Tips to manage your debt cycle 

1. Understand how debt arises: To get your finances back on track, evaluate your income, expenditure and the percentage of amount spent in paying debts. Check your credit card statements and other bills monthly and analyse them. Pick and solve one spending problem area at a time.

2. Check your affordability before spending: Loans may allow you to buy a 4 BHK home but ask yourself if you can really afford the luxury as bigger the loan, longer will be debt phase. Or buying a 2BHK fits in the bill perfectly as you will be debt-free in next 5-6 years. Don’t let lucrative offers take your mind of what installments you can really afford to pay on a monthly basis while managing other expenses.

3. Use your credit card wisely: The purchasing power that credit cards give appears like a boon but go on to become a bane when one begins to splurge. When you don’t pay off the outstanding in the stipulated time, you start paying interest on even small items like movie tickets. Use the credit cards smartly to avoid any trouble.

4. Reassess the reason for taking a loan: Choose wisely what you are willing to go into debt for. Getting a loan for further education or buying a home are seen as investments that will give high returns in future but borrowing money to buy designer clothes that will go out of fashion next fall will extend your debt cycle.  

5. Prepare a budget & stick to it: Be mindful of what you are buying. Pay all outstanding bills first and don’t let any late fee be levied. By merely sticking to a well-made grocery budget can help you save thousands of rupees every year. And start using debit cards or cash to pay.

6. Save for emergencies: Ever heard of rainy day funds? Well, these are savings you do that help you from going into debt in cases of financial problems or unforeseen situations like loss of the job, share market crash, a fatal accident, natural calamity, etc. Start building such an emergency fund.

7. Start paying off your debt: If there are no prepayment fine, try to settle your debts by paying bigger installments. Mere lifestyle changes like savings, spending less on things that are not very important can be used in paying the outstanding in credit cards. This might look difficult but debt-free life is much comfortable.

Reaching the goal of being debt-free takes just a little planning and a lot of will power of not indulging yourself. Following some of the above steps can reduce your debts significantly. Once out of debt, try and maintain that habit for lifetime.