Taking A Personal Loan? Here’s How to Avoid Getting Into the Debt Trap

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Nowadays, it’s so easy to access unsecured personal loan.   The many loan apps and websites around make it possible for people to obtain loans without the usual collateral requirements of regular commercial banks/financial institutions. 

All they need is the borrower’s Bank Verification Number (BVN). 

Here are some of the apps and websites where you can get quick loans without collateral

And you can get as little amount as 10,000 and as much as 5,000,000.  Hence, there’s an increasing number of people besieging these platforms.

But paying back loans is not as easy.  As a result, some borrowers resort to borrowing from one lender to pay another.  Soon, it becomes impossible for the borrower to service all these loans and still meet his basic family needs.

He gets into the debt trap.  Being trapped in debt can be traumatic.

Someone had to come to a social media group to share his frustration:  

I need your advice everyone. I have a debt of over 300k .

I am owing people, bank and owing other loan apps, 9 credit,

quick check, okash, kash kash, fair money and aella. All these loan

apps will be due this week and they will start embarrassing me.

I am tired of using debt to pay debt. don’t know how to survive again.

This individual is not alone in this state of quagmire.  Some are trapped without even knowing so. They only realize the mess they are in when their creditors start knocking on their doors.

Why People Gets into the Debt Trap

Taking a loan is not bad in itself.  Almost every one at a point needs to take a personal loan to meet emergency expenses,  buy needed domestic appliances, pay off mortgage and finance vacations amongst other things.

However, the problem arises when one is unable to pay back on due date.  Several reasons can account for this and if properly handled can be easily resolved.

Unfortunately for many people situations like these often trap them into debt.  Here’re a few reasons why one harmless personal loan can lead to a debt trap.

#1. Borrowing above your earning capacity

A lot of people are tempted to borrow above their earnings.  If you are a salary earner, your income is fixed. Unfortunately your expenses are not. So it could be tempting to borrow more than what you earn to meet outstanding obligations.

But that’s how your problems begin.

As a rule, cash outflow in terms of monthly repayment must not more than 40% of your monthly earnings.  This is to say that what you pay out as loan repayment, including principal and interest must not be more that 40% of what you earn in a month.  That way you have 60% of your salary to spend on other things.

When you use a larger proportion of your earning to meet your monthly personal loan obligations, it becomes difficult for you to survive the month on what is left.  You will have to recourse to borrowing more to survive and then the cycle sets in.

#2. Borrowing to meet discretionary need

I have seen a lot of people acquiring assets or purchasing items that they really don’t need.  This is called discretionary spending.  Money you spend on what is not necessary.  

What is discretionary will vary from one person to another depending on their present circumstances.  A

The most unfortunate thing anyone can do to himself is to borrow money to spend on discretionary needs.  Similar to this is borrowing money to finance consumption.   Borrowing this way is usually a source of money troubles to so many people.

The right way to borrow is to use the borrowed fund to finance income yielding assets.  That way, the income from the assets pays back monthly loan rental and reduces pressure on your earnings.

#3. Wrong use of Credit Card

The use of credit cards offers many advantages.  When you use credit cards consistently to make purchases instead of your debit card, you gradually build your credit history.

However, bad use of credit cards is one of the easiest ways of falling into debt.  Bad  credit habits will impair an individual credit score and cause him financial troubles.

Some of the bad use of credit cards to avoid include:

-obtaining multiple credit cards.  Some have 2, 3, or even 10 credit cards.

-paying back late, 

-using your credit card for all kinds of purchases,

-deliberately exceeding your credit limit,

-transferring balances, amongst others.

#4. Borrowing a fresh loan to repay an existing one

This is a sure step to getting trapped.

Most people are tempted to borrow a new loan, possibly from another source to repay an over due loan.  Some time with a longer spread of what they may consider to be a more friendly term.  It is called Debt Consolidation.

Finance experts may argue that consolidating loans makes it easier for the borrower to manage since he will be dealing with one creditor.  But it really does not solve the debt problem.  

Consolidating loans will most of the times requires that the borrower provides a collateral.  This may be a house, a car, stocks or other financial instruments that you own.  If the debtor fails to perform according to term, he loses his asset.

The borrower may also have to pay higher interest rate.  And most times, the comfort the borrower think he has with the extension of time is unfortunately, illusionary.

So what solves your debt problem is good money habits.

#5. Spending Money You are yet to earn

This is very bad money habit anyone can have.  And many do have them, especially professional people in employment.  

How often do you buy things on credit based on that bonus that you will be paid at the end of the year.  Or that utility allowance that is due in three month’s time.

When the money eventually comes you discover that it cannot meet your current needs. Then you have to borrow and move deeper into the debt lane.

If you want to avoid the debt trap, stop counting your chicken before they are hatched.

Personal Loan: How Not to Get Into the Debt Trap

Like I said earlier, taking out a loan can help you accomplish many things.  As a matter of fact it is an essential part of personal and business finance.  

But loans must be properly managed, else you get into the debt trap.

Here are strategies you can use to avoid the debt trap even as you take loans to meet your important needs.

#1. Discipline

In my discussions with clients who are in this situation I found that majority of them get into debt due to lack of discipline.  The fact that there are a number of apps and websites that give you access to unsecured loans, does not mean you should go on a binge.

Access these loan apps and websites only when it is necessary.  I have seen people go to different apps to access the minimum they can offer just for the fun of it.

But loans must be paid and when the time comes for them to pay they realize that there other things they need their money for.  Gradually these little little amount loans accumulate, become over due.  

#2. Don’t Buy What You Cannot Afford

It is normal to crave for all the good things of life.  But it is healthier if you spend within the limit of your income.  Borrowing money to acquire assets or finance a life style far above your means, is courting a personal disaster.

Some body took a personal loan from his company to send his girl friend on a vacation.  Another borrowed from one of the unsecured loan apps to fund his a birthday bash.  If these are not unhealthy borrowing, show me what is.

It’s even more so with people who use credit cards.  Credit cards create money illusion. It gives you a false confidence that you can spend the money you don’t have.  

Truth is that if you can’t pay for something you need, you really can’t afford it.  Don’t borrow to pay for what you can’t afford. Focusing on your needs is one sure way of avoiding unnecessary spending. 

#3. Pay Off One Loan Before You Take Another

You get into the debt trap the moment you start borrowing from one source to pay another.  Be it a non-interest loan from friends or family, unsecured personal loan, car loan, mortgage loan.  As much as you can, try to pay off one before embarking on another.

Only you can stop the cycle of crisis. If you use credit card, pay it off as you go!

#4. Have a budget

Budgeting helps you plan your spending.  A budget also help you maintain a level of discipline.  If you make a budget and, most importantly, stick to it. you will not likely spend unnecessarily.  Whatever you can’t afford now, postpone it, plan for it.  

#5. Create Multiple Sources of Income

One most important reason why most people resort to borrowing is that they don’t earn enough.  The reality with most salaried people is that they are broke before the next pay day.  Their earnings are not enough relative to their needs.

So it is natural to borrow in order to be able to meet their ever growing needs.  Trimming your expenses, budgeting, sticking to a spending plan and all other strategies can only go so far.

Creating multiple sources of income is your answer to being broke before pay day.  When you have more than one source of income, you discover that your salary will mostly go to saving and is available to meet major financial needs. 

What you earn from other sources, you use to meet your recurring expenses.  Fortunately, it is so easy these days to develop multiple income sources.  The internet throws up enormous opportunities at us.  

Set up a side business, develop a high income skill and offer valuable services as a side hustle, become a freelancer.  There are so many things out there that you can do on your spare time to make more money.  Do it, rather than always running to the loan apps for help.

Final Words

Borrowing is part of our daily lives. But some do it irresponsibly and therefore create for themselves, personal financial crisis.  A borrower is always a slave to the creditor, a sayings goes.  However, responsible borrowing can be healthy and helpful. 

To avoid embarrassing moments where creditors are using all means necessary to harass your life, stay within your limits, inculcate discipline behaviours and cultivate positive money habits.

Know that borrowing is not fund.  It is a serious business.

Buchi creates content and leads the Team at Kobotalk Management Services; a business development and investment consultancy firm. He provides strategic advisory to help SME's, small business owners and HNI's grow profitable business and make informed investing decisions.

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