If default is imminent, ask lender to restructure loan

Options like swapping higher –cost debt with lower-cost one or debt consolidation will help.

The recently published Financial Stability report of 2023 reveals that retail loans have grown at a compound annual growth at a compound annual growth rate (CAGR) of 24.8 percent between March 2021 and March 2023. Over the same timeframe, the share of unsecured retails loans (expressed as a percentage of total retail loans) rose room 22.9 percent to 25.2 per cent. May 2023 saw credit card spends reach a new high of about Rs 1.4 Trillion.

Media reports suggest that The Reserve Bank of India (RBI) may increase risk weights on unsecured loans, which include personal loans and credit cards, to tamp down their rapid growth. In these times of high inflation, elevated borrowing costs, and jobs losses in certain sectors, borrowers should tread cautiously when availing unsecured loans. And they should act swiftly when they find themselves sliding into a debt trap.

Keep borrowing under control

An individual’s total equated monthly instalments (EMI) on various loans should not exceed 40 percent of net take-home salary. “Assuming around 30 percent of your salary is allocated towards home and car loan EMIs; you retain a buffer of a further 10 percent points for repaying unsecured debt, such as credit card outstanding or personal loan EMIs.

Act before you default

If you are on the verge of defaulting on a loan, communicate with your lender. “The natural impulse is to run away from the lender. That should be avoided,”The vicious cycle of missed payments, late fees, penal interest rates, etc, will cause your loan amount to snowball further.”

Let’s now discuss a few strategies that can help a borrower extricate himself from a debt trap.

Address costliest debt first 

Start by ranking your debts in decreasing order of interest rate, and focus on repaying the most expensive loan first. Consider reducing your EMI next. “Liquidating assets like gold, shares etc, to repay borrowings is a viable way to achieve this”

Go for loan restructuring

Borrowers should also consider restructuring their loans, which means requesting the lender to lengthen the tenure and reduce the EMI. Borrowers should also try to swap higher-cost loans, such as credit card debt (interest rate between 30 and 42 percent), with a personal that might be available for an interest rate between 10 and 20 percent.

“A top-up or an existing home loan can also be utilised to reduce the burden of unsecured debt”

Consolidate your debts

Debt consolidation refers to the conversion of multiple smaller loans into one large loan. ”Securing this larger loan might require you to put up collateral, but the interest rate is likely to be lower and the tenure could be longer, both of which would lead to a lower EMI, “The loan can only be utilised to repay existing loans, all of which must be settled within a specific time-frame. Further borrowing is also not permitted, even in emergencies, “warns Shetty.

Mend your credit score

Those struggling to extricate themselves from a debt trap should consider seeking professional help. Once free from this trap, the focus should shift towards improving one’s credit score.

“Building a good repayment track record is the key to this” Maintain a contingency fund equivalent to six to nine months of household expenditure. “This ensures you won’t need to borrow even during temporary financial troubles, such as job loss or prolonged illness.

 

 

DEBT TRAPS:

SYMPTOMS AND CAUSES

Borrowers taking fresh loans to repay current ones are a classic sign of debt trap

Persistent pursuit by collection agents is another

Regularly running out of cash at the end of the month, leading to additional borrowings are other signs

Not having a budget; borrowings and spending on impulse, without a concrete repayment plan can lead to a debt trap

Forgetting due date for repayment, paying just the minimum amount on credit card

Having too many secured and unsecured loans at the same time

For More Details: Pooja Manoj Gupta, visit www.giia26.com
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