The debt trap

Question: We can only afford the minimum payment on our credit card bills. Unfortunately, the minimum amount is still the original amortization for each of our personal loans and we cannot afford to pay them as well. We are being harassed by collectors left and right and the situation is only worsening our already fragile health situation. Is there a way to get a respite from our creditors?—asked at “Ask a friend, ask Efren” free service available at www.personalfinance.ph, Facebook and SMS.

Answer: Apparently, you have already fallen into a debt trap. The traditional definition of debt trap is that a borrower is forced into a cycle of refinancing because he or she can no longer keep up with the scheduled payments.

Many are quick to blame the lenders for charging high interest rates and imposing short repayment periods. But loan amortizations are always based on three and not just two factors. In addition to the interest rate and term of the loan, loan amortizations are also based on the size of the loan or the principal (i.e. present value for the time value of money junkies). And it is the borrower who decides on the size of the loan or if he or she will borrow at all, even if the offer to lend to the borrower was unsolicited.

But let us focus first on the short-term solution to your debt trap. The long-term solution will require us to sit down with you to determine your particular situation such as the events leading up to the loans you have contracted, your present and potential income, your financial goals, your risk preference and a host of other things.

With your credit card and personal loans, you could enter into restructuring or refinancing schemes. With restructuring, you request your present creditor to give you more liberal repayment terms.

Do you remember the factors on which loan amortizations are based? With restructuring, you will basically ask for longer repayment periods, lower interest rates and, if possible, a partial reduction in your principal loan balance, all with the end of reducing your amortization to what you can afford.

You will have to restructure each and every credit and personal loan you have, both from licensed and unlicensed lenders, to come up with monthly amortization levels that when added to the monthly amortizations from any housing, car and government agency loans you might also have, your total amortization should not amount to more than 30 percent of your monthly take home pay (i.e. net of mandatory deductions like SSS/GSIS/PhilHealth premiums, HDMF contributions and income tax).

Debt management is easier if you have just a few creditors. In this regard, refinancing would be the better alternative provided you get better loan terms and that you are still in good credit standing. To limit the number of creditors, you will need the refinancing lender to buy out your loans from a few if not all of your current creditors. Have them buy out the loan which is the most expensive in terms of interest rates if the refinancing lender cannot buy out all of your loans and you will need to prioritize which to have bought out.

There is so much more to talk about than what this limited space permits. For now, try the above remedies. If you need more clarification, just contact our Ask a Friend, Ask Efren free service.

One last thing; always remember that loans in themselves are not bad. Debt only leads to financial death if you abuse it. And debt is always a function of the “T”ime you pay, the “R”ate of interest you pay, the “A”mortization you pay and the “P”rincipal you repay. So, when you abuse debt, you fall into the Debt TRAP.