debt trap
A cycle of borrowing to repay existing debt, resulting in spiralling total debt.
Example
“The payday loan created a debt trap as each fee required borrowing again the following week.”
Memory Tip
TRAP — once inside, getting out requires breaking the cycle entirely.
Why It Matters
Understanding debt traps is crucial because they can quickly transform manageable debt into an overwhelming financial crisis. When you borrow to pay off existing debt, you are not actually reducing what you owe but rather delaying the problem while accumulating additional interest charges that make your situation worse.
Common Misconception
Many people believe that taking out a new loan to pay off old debt is a smart consolidation strategy that solves their problems. However, unless the new loan has significantly better terms and you stop accumulating new debt, you are likely entering a debt trap where your total obligations continue to grow despite making payments.
In Practice
Consider someone with a credit card balance of 5000 dollars at 20 percent interest. Instead of cutting expenses to pay it down, they take a personal loan for 5000 dollars at 18 percent to pay off the card. Now they have 5000 dollars in personal loan debt plus new credit card charges, and they are paying interest on both. Within two years, their total debt could reach 12000 dollars or more, far exceeding their original obligation.
Etymology
Modern consumer finance term describing the mechanism of compounding debt obligations.
Common Misspellings
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Related Terms
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