Here's how you can avoid falling into a debt trap amid COVID-19 pandemic

The COVID-19 pandemic has severely hit the financial well-being of people. Retail loans in India almost doubled in 2020 as compared to 2017, as per a report by TransUnion CIBIL. Digital lending of small amount has further accelerated the demand. Is it a good idea to avail easy credit in case of an emergency? Is it avoidable? Should you dig in to your investments instead of taking loans? Here's all you want to know about avoiding a debt trap in case of emergencies.

The most important thing is to be prepared for emergencies like medical crisis during COVID times. You should have an adequate emergency corpus and an insurance cover to cushion against contingencies. "Financial emergencies are dreaded by everyone. In case someone has not created an emergency fund, this pandemic times has made it much more inevitable," says Nitin Shahi, Executive Director of Findoc, Financial Services Group.

Another factor which impacts readiness for an emergency is having adequate health and life insurance coverage. As per Aatur Thakkar, Co-founder and Director at Alliance Insurance Brokers, a sufficient insurance cover is as important as having savings in a bank.

A major hospitalisation can cost anywhere between Rs 3 lakh to 10 lakh. An event where you don't have a health insurance policy can easily eat up your savings and lead to a debt trap, especially during COVID times where the probability of multiple people in a family getting admitted is high, he explains.

"Every increase in your income leads to an enhanced lifestyle for you and your family. This financial support must be secured in case of an unfortunate event. A term insurance plan ensures that in a scenario where the breadwinner is no more, his/her dependents are provided the financial support required to maintain their lifestyle and do not get into a debt trap. Also, it ensures any existing liabilities taken by earning members can be paid off," says Thakkar.

Also read: Ask Money Today: Is it possible to create a retirement corpus of Rs 4 cr in 10 years?

You life cover must be equal to your household expenses plus inflation-adjusted goals plus loans and liabilities minus savings, investments. Your insurance cover must be able to provide for your family till someone else in the family becomes the breadwinner, or till your retirement from financial responsibilities. Similarly, your health insurance will depend on several factors like your standard of living and the medical charges of the kind of hospitals you visit.

No insurance cover or emergency funds?

Medical emergency is an urgent situation which can't be avoided and in case one has not planned an emergency fund or an insurance cover, you may have to either opt for credit or take out some money out of the investments meant for goals in life. The choice would depend on the profile of the individual. According to Shahi, a person with a job and a regular income may go for short-term credit.

Credit is not a bad option if used wisely, however, misuse of an easily available credit can have extreme repercussions on one's financial goals.

"It is natural to panic if you do not have emergency funds, but hastily withdrawing your investments won't help. In case of short-term needs, instead of withdrawing your investments, you should consider opting for a personal loan. Things are bound to get resolved within few months, and once the situation normalises you can pay the loan," says Abhinav Angirish, Founder, Investonline.in. This will help to avoid compromising on financial goals.

However, if you are facing troubles in your work space or your income is irregular, experts believe, you can fall back on your investments in a time of need. It is a better plan than to opt for a loan to take care of any urgency and later pulling out from your investments to payoff the loan. However, such a decision should be made judiciously.

If you are forced to withdraw your investments, you must do so first from the goals which are negotiable and can wait or be surrendered completely, says Angirish.  Non-negotiable goals such as retirement and child's education should not be traded-off, as far as possible.

"A foreign vacation might not matter much in critical times, but retirement and children's education do matter. Thus, you must make sure to continue your investments in long term goals," he adds.

The underlying fact is that we should understand the relevance of proper insurance planning and emergency funds to stay away from an avoidable debt, says Shahi.

Also read: Illness to wellness: How to get insurance discounts by staying healthy