Understanding High-Interest Debt

High-interest debt can be a significant barrier to achieving your financial goals. When a large portion of your monthly payment goes toward interest, it can take a long time to reduce the principal balance. This interest can accumulate quickly, costing you more each month. Let’s explore what high-interest debt is and how you can effectively pay it off.

What Is High-Interest Debt?

High-interest debt is generally defined as debt with an interest rate of 8% or higher. Interest rates represent the cost of borrowing money and are typically expressed as a percentage. Whether it’s a student loan, mortgage, auto loan, personal loan, or credit card, you’ll likely pay interest on your balance until the account is paid off.

Credit cards are notorious for having higher-than-average interest rates. With revolving credit, you can borrow as needed up to the credit limit. As you pay down your balance, you’ll free up more space to borrow again. You won’t incur interest charges if you pay off your balance in full each billing cycle.

Examples of High-Interest Debt

Interest rates vary widely depending on the loan type and lender. Your creditworthiness also plays an important role. Borrowers with less-than-perfect credit may be seen as more likely to miss a payment or default on their accounts. As such, lower interest rates are typically reserved for those with strong credit. Here are some common types of high-interest debt:

• Credit Cards: As of the second quarter of 2023, the average credit card annual percentage rate (APR) was over 22%, according to the Federal Reserve. For example, a $5,000 credit card balance with a 22% interest rate and a minimum payment of $150 would take five years to pay off, costing nearly $2,800 in interest.
• Personal Loans: Taking out a personal loan with bad credit could result in an exorbitantly high interest rate, sometimes upwards of 30% or more.
• Payday Loans: These short-term loans are designed for borrowers who need money fast and usually have minimal credit requirements. However, they tend to charge high interest rates and fees, with APRs as high as 400%, making even small loan amounts difficult to pay off.

How to Pay Off High-Interest Debt

1. Review Your Debts

Start by listing all your debts, including their interest rates, balances, monthly payments, and due dates. Review your budget to see how much extra money you typically have left over each month after paying your bills and setting aside funds for emergencies. This extra money can be used to pay down high-interest debt. If your budget is tight, consider reducing your monthly expenses or picking up a side gig to free up more money for debt repayment.

2. Choose a Debt Repayment Strategy

There are multiple ways to pay off high-interest debt:

• Snowball Method: This approach prioritizes your lowest balance first, regardless of the interest rate. As you pay off each account, you apply the money you were putting toward that balance to your next lowest balance, and so on. The snowball method uses small wins to boost motivation.
• Avalanche Method: This method prioritizes the account with the highest interest rate. It may take longer to pay off each account, especially if you have large balances, but it saves you the most money in the long run.
• Debt Consolidation: Combine multiple high-interest debts into one larger debt with a lower interest rate. This method simplifies your payments and can save you money if you secure a consolidation loan with a lower interest rate.
• Balance Transfer Credit Card: Use a balance transfer credit card with an introductory 0% APR to transfer your debt. Aim to pay off the balance before the promotional period ends. While you may pay a transfer fee of around 3% to 5% of the amount transferred, the interest savings can outweigh these costs.

3. Consider Credit Counseling

If you feel overwhelmed by high-interest debt, credit counseling might be beneficial. A credit counselor can provide personalized financial advice on paying off debt, budgeting, saving, and more. Nonprofit credit counseling is usually an affordable option. In some cases, a counselor may suggest a debt management plan, where they negotiate lower monthly payments and interest rates on your unsecured debt. There’s a fee for this service, and you’ll be required to close those debt accounts, but it may be worth considering.

The Bottom Line

High-interest debt is expensive and can take a significant bite out of your monthly budget, making it harder to reach your financial goals. The key is to get organized and make a plan for paying it off. Whether you take a DIY approach or enlist the help of a credit counselor, having a strong emergency fund can help you manage financial surprises without accumulating new debt.

At O1ne Mortgage, we understand the challenges of managing high-interest debt. Our team of experts is here to help you navigate your financial journey. Call us today at 213-732-3074 for any mortgage service needs. Let us help you achieve your financial goals and secure a brighter future.