To avoid falling into a debt trap your first task is to understand how to spot any one of the various snares that can end up compounding your problems rather than improving them.
Here is a look at how a simple temporary lapse of judgment can have far-reaching financial repercussions, including the good and bad points about credit cards, why equity in your home is not always the best way of borrowing money, plus a tip on when it pays to resist the temptation to assist someone in need of financial help.
Credit card spending
If you are going to compile any sort of list of potential debt traps credit cards are going to be somewhere near the top as one of the biggest potential threats to your financial well-being, despite their obvious benefits.
You could easily describe credit cards as being very useful but at the same time, they can easily make your financial situation a lot worse if you don’t use them properly.
There are numerous ways for card companies to charge you extra fees on top of the high-interest charge they already apply every month you leave a balance outstanding that carries forward.
If you use your credit card wisely and pay off the balance when the statement comes in they can be a useful financial tool to keep track of your finances all in one place. The problem comes when you are late with your payment, go over your credit limit, or decide to take their offer of a cash advance.
Any of these three scenarios are a debt trap waiting to happen. Pay your credit card even 24 hours late and you instantly add at least $35 to your balance in fees. Go over the limit without knowing it and that’s another way to charge you. Finally, cash advance fees charged by most card companies are often in the region of between 2% and 4%, which might seem a small price to pay for the convenience of some extra cash when you need it, but that charge is normally applied each month on top of standard interest fees.
Credit cards are an expensive form of borrowing and additional fees take them to an even higher level of entrapment, so use them cautiously and avoid leaving a balance owing beyond the statement date.
Using equity in your home
If you are a homeowner your property is likely to be your biggest asset and if you have owned your home for a while there is a good chance it is worth more than you paid for it.
Another classic debt trap is to treat your home as though it is an ATM machine and keep borrowing against it when you run short of cash or want to buy a big ticket item.
Borrowing looks cheap because interest rates are low at the moment but what you need to remember is that you are spreading the loan over a long period of time. This means that borrowing $10,000, for example, might seem cheap but paying it back over 20 years or more will become very expensive.
You are also eating into your equity which means you have less money to use as a down payment when you move, and less money to fund your retirement plans.
If you have a number of debts and want to consolidate your borrowing you can read about your options at https://www.debtconsolidationusa.com/articles/how-does-debt-consolidation-work.html in order to get some more information, which might include using your equity as a solution.
Make a balanced decision about your debt clearing options and don’t fall into the trap of thinking that your home is an easy solution.
Helping someone else is not always a great idea
It’s good to offer your help to family and friends on a whole number of things but one area where you need to politely say no is when it comes to agreeing to provide a helping hand financially by agreeing to co-sign a loan.
There is no other way of putting it, co-signing is a debt trap that you definitely want to try and avoid no matter how obligated you might feel to help out.
Putting your name to someone else’s debt is really no different to taking out the loan yourself. They might make all the payments and you don’t get called on pay the debt, but circumstances can change and you could find yourself in the frame and be expected to pay instead.
On top of that, if you need to take out a loan in the meantime you might find yourself being denied because you already have too much debt as a result of co-signing, which counts toward your current debt levels.
These are just some of the debt traps that can add to your financial burden so think carefully about the consequences before making any decisions about money.
Francesca Hayward is a personal financial consultant who enjoys helping people do better with their money. Her articles appear on many money and finance websites.