There is a saying that “What you don’t know CAN’T hurt you!” Do you believe that? What about “Ignorance Is Bliss!”
Just think about the mouse that sees a piece of cheese. It looks like food sitting on some weird looking contraption; no one’s around so why not take it. He goes for the cheese and the rest is history. Rest in peace!
I think you will agree with me “What You Don’t Know Can Hurt You!” And “Ignorance is not Bliss! It can mean death. In the financial world, a debt trap could mean financial death.
What is a debt trap? A debt trap lures people into debt that is impossible to pay off. Often there are high interest rates, hidden costs, fees or penalties that keep people from paying off the principal on the loan. Let’s look at two types of debt traps: payday loans and credit cards.
This is how a payday loan works. The lender offers a loan usually not more than $500 to an individual to help them with an unexpected expense, like a car repair. The agreement is to repay the loan in two weeks with 15% interest. When the loan due date arrives two weeks later, the debtor realizes that he can’t repay the loan of $500 plus 15% interest, $565. They go to the lender and the lender promises to extend the loan two more weeks if the debtor pays the interest of $65. Two more weeks go by and the debtor still can’t repay the loan and the lender extends the loan two more weeks after the debtor pays another $65. This cycle just keeps going and going. This debtor is now paying $130.00 a month in interest on a $500 loan. This is 15% interest for two weeks not 15% annually. This is why some people are paying 390% in interest annually on payday loans. According to the Washington Post, Payday loans are big business – $7.4 billion annually. “The typical customer spends five months on the hamster wheel and pays $520 in fees for the original loan of $375. One thing that you may not know is that there are some people who have fallen so deep down this rabbit hole that they don’t know how to get out. There are people who are juggling several payday loans from different payday loan companies. Payday loan cycles are hard to break, not to mention that once you go down this path it will be very hard to get help from a traditional financial institution because they will see you as a credit risk.
Next, I want to talk about credit card debt traps. Paying the minimum monthly payment on a credit card can trap you in a cycle of debt. You are headed for this credit card trap if you are basing your decision to use or obtain credit on paying the minimum monthly payment. Instead, you should be looking at how much interest you will pay over the life of the loan. According to the Huffington Post when you pay the minimum monthly amount you can double your debt. For instance, credit card debt of $15,000, interest rate 17%, and a minimum payment of $250 a month – will take 135 months to pay off which also translates into a little over 11 years. Creditors are only interested in making profit so they want you to only pay the minimum monthly payment because they earn more interest. It is good for the creditor but you are in danger of falling into the credit card debt trap. All it takes is one mistake to snap the trap. Most credit card companies require you to make your payment at a specific time on the payment due date. If you miss that deadline it will probably mean late payment charges and can include interest rate increases.
Finally, how do you avoid debt traps? It is important to read the small print and perform your due diligence. Do some research before you decide to get a loan or credit card. You can avoid debt traps if you can identify them and know how they work. The best way to avoid debt traps is to create an emergency fund that will be used when you have unexpected expenses. Because when we are desperate to obtain something we need, we are blind to the dangers in front of us.
Remember, what you don’t know can hurt you. Be careful!
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