10 tips to avoid getting into a debt trap

Love for debt (and EMI driven lifestyle) can be detrimental to your financial life.  It can make compounding work against you and may deter you from reaching your financial goals. Hence, it is important to avoid getting into debt trap if one is aiming for financial independence or partial financial independence. Here are 10 tips to avoid getting into debt trap.

(Zeroth tip – Get out of debt by paying off your existing debts. This is the prerequisite before embarking on avoiding debt)

10 tips to avoid getting into debt trap

  1. Create a budget and stick to it. Keep your expense less than income. Have enough room for saving (and investing) money.
  2. Invest money before spending. Put your investments in an autopilot mode if possible. If you can’t control your expenses, make the invested money difficult to access (e.g. put in PPF or a ELSS or a bank account where you don’t have ATM access)
  3. Don’t make major purchase decisions on whim. Think over it. Give it some time (say, a week or month, depending upon the purchase to be made) before actually making the purchase. You may probably realize that not all such “necessary” purchases were actually that necessary.
  4. Avoid chasing a lifestyle you can’t afford. So, if partying every alternate day is not in your budget, don’t do it. If you can’t afford an exotic foreign vacation, don’t go for it. Borrowing money (e.g. personal loan) for non-essential consumption can be one of the worst things you can do to your personal finance.
  5. Use credit cards only if you have a reasonable degree of self control. If your desire to spend using credit card overpowers your desire to control spending, you may be better of using cash rather than credit card & then falling into credit card debt.
  6. Calculate price of  major purchases in terms of – how much you will pay if you take a EMI. What would your money be if you invest the difference amount? For example, if you buy a big car on EMI (when a smaller one with cash would suffice), you are not only paying more, but also denying an opportunity to the “saved” money to grow.
  7. Tax benefit should not be a reason for buying a house on loan. If you are buying a house, understand if you require a loan first of all (most people do!). If you are taking a home loan, try to keep the amount low (typically less than one-third of your take home pay). However, with home loan, you will not be debt free, but may have a manageable level of debt, especially if you are staying in it.
  8. If you feel tempted to take a debt for a major purchase, check if part-selling of investment help you buy it. Better still, avoid that expense if it is not needed.
  9. Avoid car loan. If you can’t pay for your car in cash, consider buying a used car. Delay the purchase, if you can’t pay for it upfront (and not having a car doesn’t have much adverse effect on your day to day life). Anyway, your car is not going to appreciate in value.
  10. Keep a contingency fund -Lack of it can ruin even best laid “deb-free” plans. I would recommend 6 – 12 months of emergency expense accessible to you at any given point of time. In addition you need to be sufficiently insured (at least health insurance & term plan if you have dependents)

While avoiding debt may not make you financially independent, it can be an important foundation upon which financial independence can be built. So, I’ll suggest to stay away from debt as far as possible. It can help you build a non-shaky foundation at least.

Have anything else in mind? Do share.

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