What Is a Debt Trap?

Malcolm Tatum

Debt traps are financial situations in which consumers or business entities amass debt in order to achieve a goal, but ultimately create additional financial hardship as a result. Getting out of a debt trap can be extremely difficult and take a considerable amount of time and effort. For people and companies that are unable to create some sort of strategy to overcome the accumulated debt, the only way out of the trap is often bankruptcy.

Avoiding the use of credit cards is a great way to keep from falling into a debt trap.
Avoiding the use of credit cards is a great way to keep from falling into a debt trap.

A consumer debt trap can be created in one of several ways. One example has to do with taking out a debt consolidation loan in order to retire a collection of credit card and other debts. This approach can work very well, as long as the interest rate on the loan is less than the cumulative rate on the debts being retired, and those credit accounts are not immediately run up once again. When more debt is amassed on those accounts even as the consumer is still paying on the debt consolidation loan, a financial trap is created that often leaves the individual in worse fiscal condition than before.

Getting out of a debt trap can be extremely difficult.
Getting out of a debt trap can be extremely difficult.

With both individuals and businesses, the debt trap is often linked to spending in the hopes of having money to settle the debt later on. The result is a burden that becomes extremely hard to manage if those anticipated funds do not appear. For example, if a college student amasses significant educational loans with the anticipation of landing a job in his or her field making a certain minimum salary within six months after graduation, and that job does not materialize, the student loans become a debt trap that will be around for many years.

While few households can manage to avoid all types of debt, there are ways to minimize the chances of being caught in a debt trap. One approach is to manage credit responsibly and resist the temptation to use credit lines to purchase items that are not necessary. When lines of credit are used, pay them off promptly to avoid the accumulation of interest charges. Make sure the monthly income is sufficient to cover all basic living needs and manage the amount of any monthly installment payments such as car loans and mortgages. By living within the income generated by members of the household, steering clear of any debt trap situation is much easier to manage.

In like manner, business can use many of the same approaches to avoid creating debt trap situations. Keeping operational costs as low as possible while also maximizing profits on products sold will go a long way toward helping to keep the company financially solid. In addition, planning expansions based on conservative estimates of future income from investments and revenue generation will also keep the chances of falling into a debt trap lower.

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