What Is High-Interest Debt?

High-interest debt can make it harder to reach your financial goals. If a large chunk of your monthly payment is going toward interest, it might take a while to chip away at the principal balance—and that interest can add up fast, costing you more and more each month. Here’s a closer look at how high-interest debt works, along with steps you can take to pay it off.

What Is High-Interest Debt?

There isn’t one firm definition of high-interest debt, but it’s generally seen as debt that has an interest rate of 8% or higher. An interest rate is the cost of borrowing money and is 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 known 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’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. (The good news is that it’s never too late to turn your credit around.)

With that said, here are debts that commonly have high interest rates:

  • 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. Let’s say you have a $5,000 credit card balance with a 22% interest rate and a minimum payment of $150. If you pay that amount every month (and don’t charge anything additional to the card), it’ll take you five years to eliminate the balance—and you’ll pay nearly $2,800 in interest.
  • Some personal loans: Taking out a personal loan with bad credit could result in an exorbitantly high interest rate. Upwards of 30% is 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%, which can make even a smaller loan amount difficult to pay off.

How to Pay Off High-Interest Debt

1. Review Your Debts

Begin by listing out 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 uses the same technique as the snowball method, except that you prioritize the account that has 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.

You can find out where your credit stands by checking your credit scores and credit report with Experian at any time to see where you stand.

The post What Is High-Interest Debt? appeared first on Experian’s Official Credit Advice Blog.

https://www.experian.com/blogs/ask-experian/what-is-high-interest-debt/

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