What is a debt trap?
Quick insights
- A debt trap occurs when consumers take out loans or lines of credit to pay off other debt.
- A cycle of debt can negatively impact your credit score.
- Several proactive strategies exist for managing debt and working to avoid a debt trap.
Debt traps can occur when you continue to borrow money in order to pay off debts, leading to compounding debts and more interest charges and fees. This may negatively affect your credit score, which could be considered in future credit decisions. If you want to know more about debt traps and ways to avoid them, read on for some strategies.
Ways of avoiding a debt trap
Having a lot of debt may affect factors that influence your credit score (like credit utilization) and may be considered by lenders when evaluating applications for products such as auto loans or mortgages.
Strategies to help navigate a path forward may include:
Monitoring your credit score
Monitoring your credit score may help you understand your progress. Chase Credit Journey(R), powered by Experian™, is a free online tool available to both Chase and non-Chase customers. It is designed to help customers better understand and manage their credit score and credit goals. Customers can access their credit score anytime with no impact to their credit, receive credit tips to help improve their score and get identity monitoring-all in one place and for free.
Creating and sticking to a budget
Sticking to a budget is another way that may help keep you from falling into debt.
Keeping track of your current expenses and prioritizing the items you need, like rent and food, may provide valuable insights when creating a budget. If you can, cutting back on unnecessary expenditures may free up some funds in your budget. For example, is there a premium music streaming service you pay for but rarely use? Cutting back on these costs, which add up over time, may give you more room to pivot those funds towards offsetting your debt.
Prioritizing paying off debt
Prioritizing certain debts and using debt payoff methods may be a helpful way to approach repayment. Fortunately, there are few strategies at your disposal. They include:
- Debt snowball method: The debt snowball method prioritizes paying your smallest debt off first and then rolling the amount of that payment into your next smallest debt once the first one is paid off. You continue the cycle until you pay off the largest debt in your queue.
- Debt avalanche method: The debt avalanche method prioritizes paying off your debt in order of those with the highest interest rate first, which may lessen the amount of interest you pay over time.
- Debt consolidation: Debt consolidation is the process of combining multiple debts into a single loan or payment, typically to secure a lower interest rate and simplify monthly payments.
- Balance transfer: A balance transfer involves moving outstanding debt from one credit card to another, typically to take advantage of a lower promotional interest rate and help to manage interest charges.
Contributing to your emergency fund
Regardless of whether you have debt or not, life is filled with moments that may require you to dip into an emergency fund to cover costs for things like sudden medical expenses.
Building up your savings may serve as a financial buffer so you don’t have to take out more lines of credit to pay off sudden expenses. One way to do this is to start small. Saving even a few dollars a week or a small percentage of your monthly income may help build savings over time.
The bottom line
When debt becomes unmanageable, things can start to quickly unravel. If you’ve found yourself in a debt trap, settling your debt may become one of your top financial goals. Strategies to help manage debt include debt repayment methods, debt consolidation and creating and sticking to a budget. Building savings can provide a cushion for unexpected expenses and may help reduce the need to take on additional debt.
