Debt trap: tips and options to get out of it

As per Reserve Bank of India’s (RBI) latest Financial Stability Report, about 60% of borrowers who availed personal loans in the second quarter of FY 25 had more than three existing loans at the time of loan origination. It pointed towards rising delinquencies in the unsecured segment (including credit card outstanding) and elevated slippages to NPAs from SMA-2 category loans (loans with repayment overdue of 60-89 days).

While India’s household debt ratio of 42.9% is still relatively lower than other emerging market economies, increased slippages and rising delinquencies (in the unsecured segment) may point towards increasing incidence of debt trap, especially among the near-prime and sub-prime borrowers.

Here, I will present a step-by-step money-management strategy for borrowers to come out of the debt trap.

Review your finances

The first step towards getting out of debt trap is to assess your current finances. Start the process by listing usual expenses like daily household expenses, insurance premia, school fee, medical bills, utility bills, etc. This will help you to identify avoidable expenses for more savings.

Then, list existing loans and credit card debt along with interest rates and EMIs. This will help identify costlier credit facilities.

Finally, categorise existing investments on the basis of their linked financial goals (and the importance) and the rate of returns.

It will allow you to identify the investments that can be redeemed for making quicker repayments. For example, while investments linked to short term unavoidable financial goals or emergency fund should not be redeemed, investments set aside for discretionary spending can be used for debt reduction.

Seek soft loans

After evaluating financial situation, reach out to family members, friends or close ones for soft loans as these can help in reducing your debt burden at nil or very low interest cost.

Low-yield investments

The interest rates of most credit facilities are higher than the rates or returns offered by fixed income products like savings accounts, fixed deposits and most debt fund categories. For example, home loan interest rates, usually the lowest among retail loan categories, are now offered from 8.30% p.a., the highest FD slab rates offered by public sector banks and major private sector banks range between 7-8% p.a. Thus, those under debt burden can redeem low-yield investments, except those linked to crucial short-term financial goals, to repay high-cost debts.

Prioritise prepayments

It’s time to repay/prepay existing debt, starting with the ones with the highest interest rates. For example, if you have unpaid credit card dues and a personal loan, you should first start with credit card dues as these incur interest cost 40% p.a. and above.

Residual debt

Borrowers still left with a sizeable debt should then avail credit facilities charging lower interest rates. Those having multiple loans and/or credit card dues can consolidate them by availing fresh loans at lower interest rates.

Borrowers can also consider other secured loan options like gold loan and loan against securities/mutual funds for debt consolidation if the interest rates and repayment conditions of these help in reducing overall interest cost .

Personal loan borrowers servicing loans at high interest rates can also explore the options of transferring their personal loans to lenders offering lower interest rates.

Borrowers unable to avail the aforementioned loans or those unable to repay their credit card dues in full can consider personal loans for debt consolidation.

Credit card holders unable to avail any of the aforementioned loan options can convert card debt into EMI. While the interest rates charged on EMI conversions are higher than the personal loan interest rates, these are still a lot lower than the finance charges levied on unpaid credit card dues.

Conclusion

Thus, to come out of debt traps, stressed borrowers would have to ensure consistent financial discipline and prudent debt management strategies. Some may also require an honest reassessment of their lifestyles. While consolidating their residual debt, they should first opt for secured loan options as these have lower interest rates than the unsecured ones. To further reduce their repayment burden, they can also opt for longer tenures while availing new loan(s) for debt consolidation.

(The writer is co-founder & CEO of Paisabazaar)