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Avoid that debt trap

Is overdependence on credit cards a harmful habit? Rajiv Deep Bajaj tells us about Indians who living from paycheck to paycheck.

india Updated: Dec 13, 2007 23:06 IST

It might seem strange to speak about overspending one’s future earnings at a time when the economy is booming. But this becomes necessary in the wake of use of credit cards on a steady rise.

India has many people living from paycheck to paycheck. People don’t have spare cash. This makes credit cards an attractive option to finance necessities such as getting the gas filled in your car, buying groceries and clothes etc.

A sure sign of out of control debt happens when people have to start using plastic money for these recurring expenses. There can be many reasons for this like easy availability of credit cards, intensified marketing campaigns to boost profits etc.

Young men and women, pressed between small salaries and spiraling financial responsibilities find it very easy to get tempted with credit cards to help them get through the month. This along with the burden of student loans adds to the debt burden faced by them.

Statistics show that in a month, an average household receives eight credit card offers and on an average an individual has around three credit cards.

Credit cards have two distinct features:
a) A convenient medium though which one can spend first and pay later in full
b) The ability to spend higher levels than would be otherwise possible
People think that they can pay off the debt whenever they get a better job or that they would be fine as long as they make the minimum payment.

With credit card companies charging interest rates as high as 2.95 per cent and including fees for late payment, transaction fees, penalty if the account balance is over the limit, penalty if payment is not honoured etc, fee income accounts to almost one-fourth of the credit card companies’ total income.

What one can do is track their spending for some months to see where they are spending their money.

All over the world, people are resorting to various techniques to rid themselves of this plastic money trap and manage better their debt problems.

One such method is “Debt Consolidation”. It means replacement of multiple loans with a single loan, often with a lower monthly payment and a longer repayment period. Rather than paying off several separate bills each month, a consumer consolidates his / her debts with a financial institution that will arrange for one lower monthly payment extending over a period of time.

But one's vows are not over if one adopts this approach. Debt consolidation is also not without problems. In America, if a person takes a home equity loan or any other loan to pay off credit cards end up with the same debt load within two years. It again feeds on the same tendencies that got the consumer in his present position in the first place. By taking yet another creditor, one is adding even more fuel to the fire. In the end, it is the consumer's money that is burning. Also if a consumer is already buried under debt, chances are that he won't get qualified for those low interest rates.

What is required is debt management and not debt addition. Getting professional help in managing debt can help change credit behavior. People that have taken on too much debt tend to go into denial; they'd rather not know how much debt they owe. A professional debt manager will make them face up to their obligations.

The author is CEO of Bajaj Capital