Debt spiral
August 01, 2023A "debt spiral" is a financial term used to describe a situation in which an individual, organization, or country becomes increasingly burdened by the cost of its debt. Here's a detailed explanation:
- Initial Debt: The individual, corporation, or government initially borrows a certain amount of money, typically with the expectation that they will be able to repay the debt.
- Increasing Debt: Due to interest rates and additional fees, the total amount of debt begins to grow. If the debtor does not make substantial payments to reduce the principal debt, the amount they owe can increase rapidly.
- Financial Stress: As the debt grows, it places financial stress on the debtor, making it more difficult for them to meet their other financial obligations. They might need to borrow more money to cover their day-to-day expenses, which adds to their existing debt.
- Further Borrowing: The borrower, struggling to meet their current debt obligations, borrows more money. This could be by taking out more loans, using credit cards, or for a country, issuing more bonds.
- More Debt: The more debt they take on, the more interest they have to pay, and so the overall amount of their debt grows even larger. This leads to a cycle where the debtor is continually taking on more debt to pay off their existing debt, resulting in an ever-growing total debt burden.
- Debt Spiral: This cycle of borrowing and increasing debt can turn into a "debt spiral." The debtor is stuck in a loop where their debt continues to grow, and they're unable to break free.
When in a debt spiral, it can be difficult to escape without taking drastic action, such as major spending cuts, significant income increases, or debt restructuring. In extreme cases, bankruptcy might be the only viable solution. It's a dangerous financial situation that illustrates the importance of managing debt and living within one's means.