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What Are Debt Traps And How To Avoid Them

woman chained to a dollar signIf you are intent to grow your personal wealth, it would be difficult to do so when you are in debt. There are debt traps that can really pull you down into a financial ruin.

Some business gurus like Robert Kiyosaki say that debt is not entirely a bad thing. When you utilize it correctly, it can help you grow your money exponentially. But when you do not know how to use it properly, it has the power to rule over your life and put you in misery.

Admittedly, there are debts that has the potential to do you so much good. Things like student loans or home loans that can help increase your personal net worth. But even these debts that have the potential to improve your wealth can turn into a total nightmare. At least, it will if you end up getting yourself into debt traps.

Different scenarios that will trap you in debt

Debt comes in many forms but it is used the same way. It allows you to purchase things or avail of services that you would have otherwise been unable to pay for in cash. You do not have to wait because you can use the money of someone else to finance your expenses. Of course, that comes with a price. You have to pay back the money with interest. That is how debt becomes destructive.

The FederalReserve.gov released the most current report about the American household debt. According to their data, the total outstanding debt in November 2013 is now at $3.087 trillion. It went up from the $3.075 trillion last October. Of course, this growth may be because of the holiday shopping that peaks around these months. But regardless of the cause, it still goes to show that the credit is rising. It still means people have a bigger amount to pay for.

The fact that it is rising means consumers are not paying enough. They may not be defaulting but they are adding more debt to their overall balance. You want to make sure that you will avoid the debt traps that will keep you in financial crisis. To help you do this, here are the different traps that you may want to keep an eye out for.

  • Buying too many homes. Having your own home is great. Having more than one, is also better. But here is a word of caution. Make sure that any house that you will get in excess of where you intend to live can afford to pay for itself. Investing in rental properties is a good idea because it give you a significant amount of passive income. If you can put up a two door apartment that you can rent out for $2,000, that gives you $4,000 extra income a month. But make sure your mortgage loan on either properties will be less than $2,000 a month. That way, it can pay for itself while providing you with a small amount of income to put aside for its maintenance, insurance and taxes. If you cannot do this, then be more conservative with your property investments.

  • Enrolling in an expensive school without a plan to pay back your student loans. In general, student debt is a good idea but if you fail to pay it back on time, it can lead to a lot of problems. Among the debt traps, this is one of those that cannot be discharged by bankruptcy. Expensive and prominent schools are great choices but make sure that you have your career mapped out to pay back this loan once you graduate.

  • Co-signing someone else’s loan. This is never a good idea – even if it is for your child. There are parents who co-signed the student loan of their children and when the child ended up failing to pay for it, they had to sacrifice their retirement. Even if it is a close friend or even your significant other, learn how to say no to a co-signed loan.

  • Borrowing from your 401(k). Technically, this is your money so people will wonder how this is part of this list of debt traps. But think about it. When you contribute to your 401(k), it will be on your pre-taxed income. When you borrow from it, you have to pay it back with post-tax money. And we all know that when you withdraw your retirement fund when you retire, it will also be taxed. In effect, the same money is taxed twice. Not only that, you have to pay a withdrawal fee when you borrow money from your 401(k) during your pre-retiree years. All in all, it is really not a good debt to be in.

  • Paying only the minimum of your credit cards. Believe it or not, the only people who will benefit from you paying only the minimum are your creditors. The minimum payment is a credit card debt trap. While it will keep you from paying late penalties and ruining your credit score, it will lead you to waste a lot of money on interest rates.

All of these debt traps can really put you in a bad financial situation. You should try to avoid this as much as possible. If not, you could ruin your chances to increase your personal wealth.

Tips to keep yourself out of a debt pit

The credit traps that we discussed are all real and if you fall into them, you will really find it hard to get out of that debt pit. So here are some tips that will help you avoid them.

  • Live below your means. Some people will say that you should live within your means. While that will keep you from incurring debt, it will not give you enough money for savings. If you have financial goals, you should spend below your income capabilities. This way, your extra money can go to saving or even investing.

  • Create a budget plan as a family. Creating a budget is the right way to go. It will help you ensure that you will be living below your means. When you create the budget with the whole family, you will find more success in implementing it. The members of your household can all contribute to that budget plan and they will feel more responsible in following through with it.

  • Pursue budget friendly hobbies. Living on a budget does not mean you give up on entertainment expenses. On the contrary, you need this to make life a lot more fun to live. However, you have to consider the money you will use up on it. There are various hobbies that you can pursue and some of them are even for free.

  • Limit dining out. In a study conducted by the Principal Financial Group, the top reason why Americans failed in following their budget is the fact that they ate out a lot. 22% of the respondents in their survey mentioned how dining out is the main culprit. Just make use of your kitchen to cook and eat healthy food. That will turn out to be more economical and good for your body too.

  • Save money like it’s a bill. It is also important to decide on a money that you will put aside every month. Treat it like a bill that you have to contribute to consistently. That should help you grow your emergency fund faster.

Follow these steps to keep yourself from the destructive effects of debt traps. Make wise financial decisions to ensure that you will only put your money where it will grow.

If you have acquired some debts and it is carried over from last year, here is a video from National Debt Relief to help you find debt freedom.

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