Quick Look
- High-interest debt is generally considered any debt with a double digit annual interest rate (e.g. 10% or greater).
- The most common type is credit card debt but personal loans, private student loans, auto loans, and payday loans may also qualify.
- On credit cards, you’ll begin to owe interest any time you don’t pay the full monthly statement balance.
- High-interest debt is dangerous because so much of your payments go to interest instead of paying down the original principal.
- If you acquire high-interest debt, paying it off should be one of your most important financial priorities.
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Details
High-interest debt sucks. There are times when you may have no other option and having some form of credit or loan available that is high-interest can help you get out of a bind. But make no mistake; if it helps, it only does so at a very high cost. Your goal is to understand how it works, pay off what you have, and if at all possible, not acquire it moving forward.
Definition
High-interest debt refers to the interest rate charged to borrow money. Typically “high-interest” is anything at 10% annual percentage rate (APR) or higher.
Example: If I lend you $100 with a 10% interest rate and the interest compounds (charges interest on the interest) only once annually, if you pay me back within a year you’ll owe me: $110 (which is the principal you borrowed + 10% of that principal).
Common Examples of High-interest Debt & Corresponding Interest Rates
| Debt/Credit Source | Typical Interest-rate Range (APR) |
|---|---|
| Credit Card | 13% – 26%, variable, meaning your rate can change month to month |
| Auto Loan* | 3.24% – 20.67% |
| Personal Loan* | 5.99% – 35.99% |
| Private Student Loan* | 3.34% – 12.99% |
| Payday Loan** | 391% – Average! |
* Rates on these types of loans may range between low-interest and high-interest debt
** Payday loans are meant to be short term debt and have a different fee structure. However, translated to an APR they clearly qualify as high-interest loans and should be avoided by any means necessary!
APR vs. APY: Sometimes you’ll see “APY” emphasized instead of “APR.” APY stands for “Annual Percentage Yield” and is a reflection of the fact that the frequency with which interest compounds can affect the total amount of interest owed over a given time. All you really need to know is that most high-interest debt compounds daily which means your APY will be a little bit higher than the APR. This calculator shows it clearly.
How High-interest Debt is Acquired
Credit Cards: The most common type of high-interest debt comes from credit cards. If you use a credit card but pay the full balance before the statement due date (usually 21 – 30 days following the date you receive your statement), no true debt is acquired and no interest will be owed.
But the Federal Reserve has estimated that the average credit card debt of U.S. families is $6,270. In every circumstance, this debt came about because something less than the full statement balance was paid. So while you are only required to pay the “minimum monthly payment” as shown on your statement, if you do so you will be acquiring high-interest debt. Whenever you can, pay the full balance on your credit card statement.
Auto, Personal, & Private Student Loans: When you purchase a car with an auto loan, take out a personal loan, or private student loans, you are taking on debt. If you have less than stellar credit, it’s possible these loans will have interest rates which would qualify as “high-interest.”
If you already have high-interest debt, it’s important to ask yourself why. This isn’t about blame. But it is about being honest with yourself and understanding what got you here. Which statements below resonate with you?
- “My spending is for genuine needs and is reasonable. Unfortunately I don’t earn enough income and need to focus on making more money.”
- “I earn solid income but I almost never have enough to pay all my bills in full. It might be possible for me to reduce my expenses or purchase lower-cost items in the future.”
- “I have acquired high-interest debt but it’s for a genuine investment in my future. The extra cost is worth it to me and I won’t regret it in the end.”
In all likelihood, all three statements likely resonate to some degree. But only by being honest with yourself can you be at peace with where you are today, and create an effective plan for improving your debt situation moving forward.
Why High-interest Debt is So Dangerous
Regardless of why you have high-interest debt or what was acquired with it, the following remain true:
- You’re paying extra: Everything bought on high-interest debt now costs you the original price, plus the total amount of interest you end up paying. If you want to improve your financial health, you can’t afford to pay extra. The sooner you break this cycle the better off you’ll be.
- Someone is making money off of you: There are many valid reasons for companies to lend money. And these companies don’t have to be corrupt or nefarious to do so. But you can’t forget that the longer you are indebted to them, the more money they make off of you. In this sense, your incentives and theirs are not aligned. Therefore you need to be clued into how you acquired your debt and your plan to pay it off. The best person to look out for you…is you.
And remember: Credit card “rewards” make no sense if you’re paying interest on your debt. Even a great (and probably temporary or category-restricted) 5% “cash back” offer (and most are more like 1-2%) is completely useless if you’re paying 20% in interest. Don’t be fooled.
- The debt can snowball: If you find yourself in a situation where you are purchasing items with high interest debt that you want – but don’t need – (this could be clothing, a fancy car, travel, dining out etc.), you will not only have to pay extra for the things you bought, you will also have to break the habit that got you there in the first place. If you can’t really afford that $300 jacket today, do you really believe you’ll be able to afford it at $350 several months from now (which could be what you’ll pay when you factor in interest)?
As more of your money gets consumed by interest payments for items bought yesterday, last week, and last month, you have less available to spend on the things you need today, this week, and this month.
Put another way, if you use high-interest debt to pay for things you want now, you may soon find you’re using high-interest debt to purchase things you truly need later. And this can become truly challenging to overcome.
Calculate Your Debt Payments
To get a clear picture of how much your high-interest debt may cost you as you pay it down, you can use Bankrate’s debt paydown calculator. Regardless of the type of debt you have, you’ll need three pieces of information, all of which should be available on your most recent statement:
- Interest rate – the rate they’re charging you (remember sometimes this will be constant and sometimes it will be variable depending on the loan or conditions of the line of credit)
- Current balance – i.e. the total amount you currently owe
- Minimum monthly payment – the smallest amount the lender is requiring you to pay each month
Many Have Conquered Their High-interest Debt. So Can You.
High-interest debt can feel completely overwhelming. But there are plenty of ways to lower the debt, strategies to help pay it off faster, and eventually rid yourself of it completely. We’ll tackle these in upcoming tasks. But just know that if you have high-interest debt, you’re not the first and you won’t be the last. If you imagine what it will feel like the day you become debt-free, and follow your plan to get there, it will happen.
You’ve got this!
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