What Is a Debt Trap?

Definition and key signs of a debt trap

It’s estimated that about 50% of Americans with credit cards carry a balance on a month-to- month basis. When you factor in mortgages, car loans and student loans, it’s easy to see how common debt is for Americans.

It’s normal to have some debt: it’s a common part of modern life. 

But when your debt becomes overwhelming to manage despite making payments, or you’re taking on more debt to pay down other obligations, there’s a good chance you’re in a debt trap. 

Normal debt vs. debt trap

Debt isn’t always a problem. The question is whether you can manage your payments while steadily reducing what you owe. Here’s a closer look at how normal debt and a debt trap differ.

Characteristics of normal debt

• You’re able to make payments on time.
• You’re consistently paying down your principal over time.
• You’re able to cover monthly expenses without borrowing money.
• You have a realistic plan to pay your debt off.

Characteristics of a debt trap

• You have to borrow money to make payments on your debt.
• Your monthly payments go to interest rather than reducing the balance.
• You rely on credit cards or loans to afford your everyday necessities.
• Your debt doesn’t reduce much — or even increases — despite the payments you make. 

Warning signs you’re trapped in debt

A debt trap occurs when debt reaches a point where it becomes nearly impossible to pay it off. The most common warning sign is that your debt balance continues to grow despite your best efforts to reduce it. This can happen when:

• High interest rates make it harder to pay down the balance.
• Shifting debt from one credit card or loan to another helps you make minimum payments, but doesn’t reduce what you owe.
• Unexpected expenses force you to take on even more debt.

How quickly can a debt trap develop? 

The answer depends on the situation. 

A significant or unexpected life event like a major illness, job loss, divorce or the death of a loved one can plunge you into unmanageable debt if you don’t have enough savings. 

Debt can also accumulate slowly, lowering your credit score if you’re unable to make payments or pay down balances on a regular basis. A lower score can then make it more difficult to secure credit cards or loans at reasonable interest rates, which only makes it harder to pay debt down.

» MORE: How much debt is too much?

Common causes of debt traps

The ideal way to carry debt is to only take on what you can easily pay off, whether in full or through short-term repayment plans that are attainable. This approach ensures you don’t sink too far into debt, preserves your debt-to-asset ratio and keeps your credit score strong.

Your debt-to-asset ratio shows how much of what you own is financed by debt. A lower ratio is better.

But it’s easy to overextend yourself when the cost of goods and services rises, credit is readily available or lenders use predatory practices. And if this has happened to you, you’re not alone.

High interest rates

High interest rates are one of the most common ways everyday borrowers get caught in a debt trap.

The average credit card interest rate hovers around 19%. But if your credit score isn’t stellar, you could be charged anywhere between 22% and 28% interest on your revolving debt. This high interest rate can go even higher on specialty credit products like department store cards.

It’s easy to spiral into a debt trap with interest rates like these. Often, the required minimum monthly payment barely reduces the debt balance, if at all.

Predatory lending practices

Other factors can also contribute to debt traps, including predatory lending practices such as:

• Payday loans and similar loans with extremely short repayment periods
• Debt rollover offers, which often tack on more finance charges and even higher interest rates
• High-cost penalties for failure to pay on time or in full
• Revolving balances that allow for additional borrowing despite carrying a balance
• Compounding interest on balances carried month to month

How a debt trap impacts your credit and finances

A debt trap can affect more than your ability to pay what you owe.

As debt grows, it can damage your credit, make borrowing more expensive and put increasing pressure on your monthly budget. Here’s a closer look at how a debt trap can affect your credit and everyday finances.

Credit score and credit utilization

Your credit score is based both on your ability to make consistent on-time payments and your credit utilization ratio, in addition to other factors.

Missed payments can damage your credit score, as can using most or all of your available credit. A low credit score makes it increasingly difficult to qualify for future loans and credit cards with reasonable interest rates.

Credit utilization compares the amount of credit used versus the total amount you have access to.

A debt trap can take a toll on your credit score, especially when:

• Missed payments become more likely
• Outstanding amounts or unpaid balances increase, making you look riskier to lenders
• Using most or all of your available credit leads to a high credit utilization ratio
• You apply for new credit more frequently, which can temporarily lower your score
• Your accounts are referred to collections, you settle with lenders or declare bankruptcy

Everyday budgeting for expenses

As your debt grows, more of your monthly income may go toward debt payments, leaving less money for everyday expenses and unexpected costs. If your budget can’t keep up, you may begin missing payments or relying on additional credit to cover the gap.

High interest rates, fees and other predatory lending practices can make matters worse, causing your balances to grow even when you’re making payments.

How to escape a debt trap

The first step in breaking a debt trap is to stop taking on new debt whenever possible. Pausing your use of credit cards and loans gives you a chance to assess your finances and create a realistic plan without adding to what you already owe.

Here’s a plan to help you get out of a debt trap:

1. Build a realistic budget

List your monthly income and expenses to determine where cuts can occur. Build in an amount for incidentals and surprises, which do pop up — and can derail a budget that’s too extreme.

While you can’t usually reduce your mortgage or rent payment, you can likely do the following:

• Allow yourself only one meal “out” each week
• Suspend or cancel monthly expenses like your gym membership, cable TV add-ons, magazine subscriptions, movie rentals, apps, etc.
• Vow to make no Amazon purchases for an entire month
• Turn off lights and appliances when not in use to reduce your electric bill
• Make coffee at home instead of purchasing coffee at a cafe
• Cut luxury services like massages, nail appointments and haircuts for a month or two
• Plan errands to cut down on trips out, saving gas and car maintenance costs
• If possible, take public transportation and sell your car, putting the money toward debt
• Sell items through sites like Facebook Marketplace, Decluttr or ThredUp
• Have a skill? Consider selling your product or service for additional income
• Take on a side hustle, like bartending or waitressing for a short time

2. Choose a debt repayment option

Next, consider your repayment options. Your situation might feel hopeless, but there are at least two popular plans that are designed to help you get ahead of your debt: The debt snowball and the debt avalanche plans.

The debt snowball

With the debt snowball plan, you pay off your smallest balance first, then move on to the next-smallest. Once you’ve paid off a debt, you apply the money you were putting toward it to the next balance. As you continue, the amount you can put toward each debt grows.

This approach can be especially motivating because you see progress quickly.

The debt avalanche

With the debt avalanche plan, you start by aggressively paying down your highest-interest debt, perhaps by using money you’ve saved through any of the budget-related strategies above. Once your highest-interest debt is paid off, you move to the debt with the next-highest interest rate, and continue working your way down.

This approach can help you save the most on interest as you pay down your balances.

3. Consolidate your debt or transfer balances

Consider getting a debt consolidation loan or transferring balances to one credit card with a lower interest rate.

Debt consolidation

A debt consolidation loan combines multiple smaller balances into a single loan, which can potentially lower your interest rate and simplify the repayment process.

Credit card balance transfer

A credit card balance transfer can work similarly by moving debt from one card to another, but read the fine print. Some cards offer a low or 0% introductory rate for a limited time before applying a much higher rate to any remaining (or even the original) balance.

4. Negotiate interest rates and payment plans

If you don’t have the option to get a consolidation loan or balance transfer credit card, consider reaching out to a debt relief company. Debt relief companies sometimes offer lower interest rates, a payment grace period or even debt forgiveness.

However, even though debt forgiveness can provide relief, it may also affect your credit score. If a lender settles your debt for less than you owe, for example, the account may be reported as settled rather than paid in full, which can negatively affect your credit.

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