Traditionally, Indians like to save money rather than take debt. However, the western world theories have influenced us greatly, whereby the younger generation prefers to borrow for their immediate needs rather than save for the more challenging times ahead. Such a situation can lead to a debt trap if you do not manage your finances and savings well. So, let us discuss what happens when you can’t pay off your debt.

What is the golden rule of saving?

We can segregate our income into three primary categories depending on our expenditure.

a. Our needs or essential expenditure

b. Our wants or discretionary expenses

c. Savings or paying off debt

The thumb rule of savings is that an individual should earmark 50% of the monthly income towards meeting essential expenses, 30% for discretionary spending, and the balance 20% towards savings or paying off debt. This rule is also known as the 50–30–20 Golden Rule of Savings in financial circles.

How do you fall into a debt trap in India?

If you strictly follow the golden rule of savings, there is no cause for worry because you have enough cushioning to cater to emergencies. Reducing our needs or essential expenditure is not possible. However, according to the situation, we can maneuver the wants and savings portion.

If our income is insufficient to cater to our needs and savings portions, we risk falling into debt. When the needs or debt increases to such an extent that it threatens to overcome or even cross the income levels, we become trapped in debt. Under such a situation, we borrow money to stay out of debt. In simple words, we create more debt to pay off existing debt. It is a vicious cycle that can prove challenging to come out of. Thus, we enter a debt trap.

In local parlance, we term this situation as “Aamdani Athanni, Kharcha Rupaiyya.” The translation goes like this, “Income is Rs 0.50, whereas our income is Re.1.” So, when our expenses are higher than our income levels, we fall into a debt trap in India.

Let us now discuss a concrete example of a debt trap.

In India, people avail loans for almost everything from houses to cars and education to consumer goods. Besides, personal loans and credit cards are available. Moreover, numerous apps allow people to borrow funds whenever they like. As a result, the repayment commitment increases faster than your income leading to a debt situation.

The credit card is a glorious example of people falling into a debt trap. If you use it properly, there is no better instrument than a credit card because it provides you with credit for 50 days. However, you need to pay the bill entirely before the due date to avail this interest-free facility.

Credit cards offer their customers an option to make partial payments. Observing the credit card bill, you find a ‘Minimum Amount Due’ payment option. Consumers can pay this amount to keep the card limit alive. However, it sets off a chain of debt because banks start charging interest at nearly 3% per month on every amount outstanding on that date and for the subsequent obligations until the date of payment.

How do you get out of the debt trap?

The only way to get out of the debt trap is to ensure our income is more than the expenses. You can reduce your debt by cutting off discretionary expenses altogether. Besides, you might also have to sacrifice your needs to bring your finances on track. It can be an extremely challenging situation to overcome. So, the best advice is to follow the 50–30–20 golden rule of savings as much as possible.