It was last December when one of my friends started her new job. Now, this was a friend that had trouble controlling her spending habits, and was prone to splurge when she had the means.
Due to her now higher level of income, she had many credit options open to her. Like a kid in a candyshop, she sought to make use of them all!
First, she took on a home loan. Then, she took on a personal loan from another bank to design and decorate her home.
Lastly (and this is the death knell) she bought lavish electronics, furniture and home décor goodies using a high interest personal loan from a licensed money lender.
Soon, it was in March, that she realized that she wasn’t able to save a cent of her income and is now facing difficulties in even meeting her basic day to day requirements (though admittedly, her expected standard of living is pretty high)!
I’m now worried that she might soon find herself in a debt trap.
What are debt traps?
Statistics say that if you keep your debt to income ratio above 36% for a long duration, you are bound to fall into a debt trap sooner or later.
A debt trap is a vicious cycle wherein the borrower keeps on re- borrowing, through different schemes, because he is unable to pay the scheduled instalments on the principal amount along with the interest accrued.
If you are in a debt trap, then you may pay a minimum interest amount to keep a good credit score, however, you never end up paying the principal amount itself and remain shackeled throughout the rest of your life!
Entering the debt trap zone
One may need immediate cash for a variety of reasons. You may need quick loans for clearing off your previous debts, home remodelling, wedding, education, meeting your monthly business expenses, daily purchases and other such needs.
If you have a decent source of income, loans may actually seem to be a mode of relief in its initial stages. After all, you have enough income to cover the repayments when it comes due right?
Unfortunately, it’s not that simple.
Most people find themselves in debt traps for two main reasons:
- They underestimate how quickly their interest can build into an unwieldly mess.
- They meet a financial emergency that wipes out their cash reserves, putting them on the back foot thereafter.
As you can see, it’s important not to be complacent about your financial situation. A crises could trap you in a vicious cycle of debt for life!
Popular types of debt traps
- Payday Debt Traps: They are short term, high interest quick loan advances that have some serious repercussions. According to CFPB, only 15% borrowers are actually able to repay these 14 day schemed loan advances.
- Credit Cards: These are based on revolving balances and the borrower is given a maximum credit limit for his monthly expenses. Though you can pay a ‘minimum payment’ to continue your card services, the interest accrued on the total sum borrowed and the principal amount itself, may become harder to pay off with time.
Third Party Money Lenders
Money lenders tend to get a bad rep worldwide. Many have engaged in marketing campaigns that target the poor, and lending practices that intend to ensnare them in a lifetime of interest payments.
Thankfully, strong regulation in countries like Singapore has helped to make money lenders a force for good.
Unlike payday debts and credit card interest rates from banks,
- Interest rates from third party moneylenders are capped at 4%
- Late repayments are fixed at $60.
- Also, the total cost of borrowing would never exceed 100% of the loan sum.
Still, not all money lenders lend equally.
Choosing a legitimate third-party lender with significant cost benefits can be a herculean task. To narrow down your worries, here are some key points that you need to consider before opting for a third party money lending scheme:
- Checking for secure and unsecure loans.
- Required equity or appraisal.
- Flexible terms (5, 10, 15 or 20 years) or Short term loans.
- Consult your tax advisor for tax aversion and tax deductible interest.
- Whether pre- payment penalties are applicable.
- Low and fixed interest rates based on current market prices.
- 100% up- front funding.
A tool like loanadvisor.sg can help you find legitimate third party moneylenders and compare amongst them easily. To make things a bit easier, some of the popular licensed moneylenders in Singapore that we’ve seen include A1 Credit, AP Credit, Advance Planners Credit, Symbolic Pte Ltd., GM Creditz, Quick Loan 101 and more.
Loopholes with Third Party Money Lending
Directives have been implemented in 26th January 2017 to tackle abuses such as misinformation, interest levied on each segment of split loans, and administrative charges for re- financing of short term loans. However, there are many loopholes that money lenders can exploit.
Here’s an example: if you take up a weekly repayment loan from a third party money lender and fail to repay the amount by the end of the week, then you would not only be required to pay a 10% administrative fee for re- contracting but, also the late payment fee, totalling it to 40% of the loan amount. These are some of the clever tricks that money lenders were legally using to make you fall into a debt trap.
I’ve seen many people fall into debt traps. And I can only advise that you avoid going anywhere near it by doing the following:
- Use your credit cards wisely. It’s better to spend no more than 25% of your monthly pay check through credit cards.
- Approach only licensed third party moneylenders in case you need some emergency cash. The moneylenders can be considered when banks have rejected your application because of a poor credit score. Note that most moneylenders secretly charge higher interest rates than banks.
- Never try approaching loan sharks.
- Approach moneylenders for small loans such as pay day loans.
- Approach a licensed moneylender like looanadvisor.sg to consolidate all your debt in the form of a single personal loan, so as to lower your interest rates.
Forgetting everything else, it’s always best to stay disciplined and keep a firm control over your spending habits so as to avoid yourself falling into an insomniac, stressful and a never ending debt trap.