Understanding and Managing High-Interest Debt

High-interest debt can be a significant obstacle 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. In this blog, we will explore what high-interest debt is, provide examples, and offer strategies to pay it off effectively.

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 will likely pay interest on your balance until the account is paid off.

Credit cards are notorious for having higher-than-average interest rates. With this type of revolving credit, you can borrow as needed up to the credit limit. As you pay down your balance, you 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. (The good news is that it’s never too late to turn your credit around.)

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, if you have a $5,000 credit card balance with a 22% interest rate and a minimum payment of $150, it will take you five years to eliminate the balance—and you’ll pay nearly $2,800 in interest.

Personal Loans

Taking out a personal loan with bad credit could result in an exorbitantly high interest rate. Rates upwards of 30% are common, though some lenders have rates in the triple digits.

Payday Loans

These short-term loans are designed for borrowers who need money fast. They usually have minimal credit requirements but tend to charge high interest rates and fees. Loan amounts are generally $500 or less, with the balance due on your next payday. According to the Consumer Financial Protection Bureau, APRs on payday loans can be as high as 400%, making even a smaller loan amount difficult to pay off.

How to Pay Off High-Interest Debt

1. Review Your Debts

Begin by listing all your debts, including their interest rates, balances, monthly payments, and due dates. Before you look at different debt repayment methods, review your budget to see how much extra money you typically have left over each month—that’s after your bills are paid and you’ve set something aside for your emergency fund. This extra money can be used to pay down high-interest debt. If your budget is tight, you can take steps to reduce your monthly expenses. Picking up a side gig can also free up money to put toward your debt.

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 take the money you were putting toward that balance and apply it to your next lowest balance until that’s paid off (and so on). The snowball method uses small wins to boost motivation.

Avalanche Method

This method uses the same technique as the snowball method, except that you prioritize the account with the highest interest rate. It may take a while to pay off each account, especially if you’ve got large balances, but your highest-interest accounts are costing you the most money.

Debt Consolidation

With this method, you combine multiple high-interest debts into one larger debt. You’ll then have one monthly payment. You can save money if you secure a consolidation loan that has a lower interest rate, and making one payment a month instead of several could be easier to manage.

Balance Transfer Credit Card

Another option is using a balance transfer credit card that has an introductory 0% APR. The goal is to transfer debt to this new card, then pay it off before the promotional period ends. You’ll likely pay a transfer fee of around 3% to 5% of the amount transferred, but the interest savings likely outweigh these costs.

3. Consider Credit Counseling

If you feel overwhelmed by high-interest debt, you might benefit from credit counseling. A credit counselor can provide personalized financial advice around 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 something to consider.

The Bottom Line

High-interest debt is expensive. It can take a big bite out of your monthly budget and make it harder to reach your goals. What matters most is getting organized and making a plan for paying it off. You might take a DIY approach or enlist the help of a credit counselor. Either way, having a strong emergency fund can help you manage financial surprises without accumulating new debt.

If you need assistance with managing your high-interest debt or are looking for mortgage services, O1ne Mortgage is here to help. Call us at 213-732-3074 for expert advice and personalized solutions to meet your financial needs.