India’s relationship with personal debt is undergoing a troubling shift. Around 68% of Indian borrowers are under some form of debt distress as they are unable to manage their loans.

Household debt stood at 42.9% of the GDP (as of June 2024), up from 38.3% just one year ago.

This means families are borrowing more and saving less. The culprit is the way people borrow, spend, and plan their money.

What was once a symptom of poor financial planning has evolved into a systemic issue. According to the Reserve Bank of India’s Financial Stability Report (Dec 2024), nearly half of all individuals with personal loans or credit cards also hold an active home or car loan.

To add insult to injury, non-housing loans grew by 18% year-on-year (Y-o-Y), making up 72% of all household debt. Meanwhile, housing loan growth was only 12% Y-o-Y.

Taking a closer look at the spending pattern, a deeper issue comes to light. In the 2024 festive season alone, consumer durable loans went up by 27%, and personal loans rose by 13%. Even the average loan ticket size for consumer durables increased by 16%.

This shows that not only are people buying more, but they are also buying bigger. This borrowing behaviour signals a mindset shift from ‘borrowing for asset creation’ to ‘borrowing for lifestyle upgrades’. And with many already juggling multiple loans, this shift is the perfect recipe for a debt trap.

How people fall into debt traps: The common behavioural red flags

Most debt traps begin with not having a budget for essential and non-essential expenses. But this simple oversight can snowball. Before you know it, you are overspending on things you do not need just for instant gratification.

Then the next misstep: treating credit card limits as spending power. Many convert credit bills into EMIs, which add long-term interest to short-term indulgences. And when these EMIs pile up, you try to escape with the help of fast-loan apps, only to stack more expensive loans on top of existing ones.

Eventually, EMIs outpace income, and defaults start. With every delayed EMI, the credit score drops, shrinking access to affordable loans even further. It’s a vicious cycle.

How to break this cycle

One of the tried and tested ways to break the debt trap cycle is by adopting the “3 bank accounts” system.

1. Earnings account: Use this account to receive your salary, and once it is credited, split funds into the other two accounts as per your budget.
2. Spending account: This account is just for paying bills, EMIs, credit card payments, and non-essential expenses (stop when it runs dry).
3. Investment account: Do not use this account for anything other than your SIPs and long-term investments.

This will help you keep your overspending in check while also inculcating disciplined investment habits.

Note: This is a personal classification that you do for yourself; such classifications are not offered by the bank.

Are you already in a debt trap?

If a debt trap announced itself, far fewer people would fall victim to it. Here are the red flags you shouldn’t ignore:

• EMIs consume more than 50% of your in-hand salary
• You can’t save for emergencies or future goals
• Your expenses are more than your income
• You’re only paying the minimum due on credit cards
• You’ve withdrawn cash using your credit card to cover daily expenses
• Your new loan applications are being rejected
• You’re missing utility bill payments, like electricity or rent

If any of these signs seem relatable, then it’s time to take action. Finology Research Desk has mapped clear steps to help you avoid this fate.

Step 1: Classify your debt: good vs bad

Understand that debt is not a villain. Loans that build long-term value (education, home, or business loans) are generally classified as “good” debt. They contribute to your net worth.

In contrast, loans for depreciating assets (cars or bikes) or lifestyle expenses (consumer durable EMI, credit card loans) are “bad” debt. These drain your finances without future returns, and must be paid off as soon as possible.

Step 2: Budget for reality

Your budget should match your repayment capacity, not your lifestyle aspirations. A sound rule you can follow is:

• 40% of income for EMIs
• 15% for savings and insurance
• 40% for essential expenses
• 5% cash buffer
   

Source: Finology

For instance, on a ₹50,000 salary, ₹20,000 should be your EMI ceiling. That gives you a total loan capacity of roughly ₹9–10 lakh at 12% interest over 5 years. Overshooting this means your financial structure is built on instability.

Step 3: Be intelligent about your repayments

List all your loans, note their interest rates and outstanding amounts.

Then use the “snowball method”. Pay only the minimum dues on all your loans and credit cards. Then, focus on closing the smallest outstanding loans first. These often have lower EMIs or smaller balances, freeing cash. This also builds momentum. Small wins create a sense of progress, boost motivation, and help you stay committed to clearing the next one.

Once you are done with that, switch to the “avalanche method”. Redirect your newly freed-up money toward the loans with the highest interest rates, typically credit card balances or short-term personal loans. This will help you reduce your total interest burden, even if the loans themselves are larger.

Step 5: Restructure when needed

If managing your current EMI is problematic, adjust it. You can extend the loan duration for personal or car loans to lower your monthly EMI burden.

You can also use cheaper credit to pay off expensive debt:

• If you already have a home or car loan, check if you can borrow a little more under the same loan at a lower rate.
• Gold loans are another option. They usually come with much lower interest rates and are easy to access.

This helps you replace loans charging 24% to 36% interest with those under 12%, easing your burden and freeing up your monthly cash.

Conclusion

Debt traps do not announce themselves; they slowly creep in with unchecked spending and ignored budgets. Soon, credit card EMIs pile up, and high-interest loans stack up just to stay afloat.

Today, non-housing loans make up 72% of household debt, driven by style borrowing and poor credit choices.

Finology Research Desk advocates a practical approach: separate good and bad debt, restructure when needed, and stay disciplined.

And still, if you are not sure where you stand?

Try Finology recipe’s Financial Health Check-up to assess your debt situation and start correcting course.

Finology is a SEBI-registered investment advisor firm with registration number: INA000012218.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.