Rolling over your loan repayments and increasing your credit limit every time you run out of cash might seem like a brilliant idea, until you realise that you have gone beyond the point of no return.
The reality is when you reach a dead end you can always make a U-turn. However, with a debt trap it is completely different, notably if you only have one source of income.
There are many ways to fall into a debt trap and it is important to uncover some of the unscrupulous behaviour from some lenders, which submerge financially distressed consumers into heavy debts.
Related: Debt trap: COVID-19 Emergency Loans
One Month Pay day loans with high interest rates
Unfortunately, many unapprised consumers rely on short term payday loans to make it through each month. Little do they know that such loans carry a significantly high interest rates which they might never be able to pay. Such loans are used to solve short term financial needs but result in a long-term financial servitude. The high interest rate of 60% per annum on these loans makes it difficult for overindebted consumers. Most consumers return to the same lender and borrow more funds after repaying the payday loan.
Warning sign! When you are in such a position and you borrow short term debt to cover your basic needs, you are clearly in a debt trap.
Constantly extending credit limits
If you find yourself always having low cash flow and, as a result, are in the a habit of using credit cards for basic purchases, then you have a serious problem.
Unfortunately, due to the revolving nature of credit cards, consumers are always tempted to use the amount available after the interest rates have been deducted. Such is the practice of a habitual offender.
Warning sign! If you are constantly increasing your credit limits and your credit utilization is over 100% you are in a debt trap (credit utilization: amount you have used from your credit card compared to what was made available to you).
In other words, if the bank gives you a credit card with a credit limit of R50,000 and you make use of the full R50,000 your credit utilization ratio is 100%. A good ratio is anything less than 40%; this means you are not reliant on your credit cards to survive monthly. In this example of a R50,000 credit limit, 40% utilization means you have only used R20,000 and still have R30,000 available and unused, which is fantastic.
When you rely on your credit card and constantly increase your credit limit due to cash flow problems, you are heading towards a debt trap, and could possibly be there.
Rolling over payment and using overdraft facilities
The statistics reveal that out of 20 million credit active consumers, 10.5 million consumers are struggling or have defaulted on their debt payments.
A simple indicator that you have reached a dead end is when you are constantly using your overdraft facility to cover your living expenses; another sign is when you have returning debit orders due to insufficient funds. This leads to a common behaviour known as “rolling over”. At this stage, you try to buy time, praying for your creditors’ mercy, hoping for an arrangement when the phone calls start coming. At this stage, you are undeniably trapped into debt.
Accumulation of arrears
Buying time is the worst strategy for any individual struggling with debt. This is because your interest rates are compounded monthly and constantly charged on top of your outstanding balance.
This means, by the time you wake up from this nightmare, you would have accumulated a colossal amount of interest rates which will make it difficult to climb out of debt.
Warning sign! When you are now falling in arrears with one or more debts, you have undoubtedly fallen into a debt trap and need to reach out for help as soon as possible.
Emotional distress when it comes to your debts and poor bank statement
Your bank statement speaks volume about your financial life, numbers do not lie. If your bank statement has constantly a negative balance, it is apparent you have a cash flow problem and need to consider increasing your income or cutting down your expenses.
Warning sign! As an indicator when you get emotional (fearful, sad, anxiety) when it comes to your financial situation, specifically on your pay day, then you have fallen into a debt trap.
What should you do?
- Reach out for help, seek financial advice, or approach a debt counsellor for help.
- Cut down on your living expenses. At this stage there are things that you can no longer afford and you need to adjust your budget.
- Create multiple income streams and increase your income. Find alternative sources of income to cover the increase in your costs. For example, you can do this by selling products/services, or by getting a second job.
- Stop procrastinating. Time can not beat the mystery of compound interest. Act now!
Debt consolidation – is it for you?