High-interest debt carries a bad reputation, and it’s well deserved.
Debt with a high-interest rate is among the most costly types for borrowers. The longer it’s left unpaid, the more it grows due to daily compounding. For example, a credit card balance of $5,000 at a 20% interest rate could add nearly $1,000 in interest per year if only minimum payments are made.
But here’s the big question: what kind of debt is considered “high” compared to others? If you ask the average American, chances are each person has a different definition of unreasonable debt. According to the Federal Reserve, in 2023, the average credit card interest rate in the U.S. was over 20%, often considered “high” compared to rates for secured loans like mortgages, which averaged around 7%.
Today, we’re here to clarify what qualifies as high-interest debt and to share tips on how best to avoid it.
So, without further ado, let’s dive into everything we know about it.
What is High-Interest Debt?
There’s no universal definition of high-interest debt. However, many financial analysts consider high-interest debt to have an interest rate of 8% or above.
High-interest rates are often seen with mortgages and student loans. Besides, unsecured debt tends to have higher interest rates than secured debt, which is typically backed by assets like a home or vehicle. For example, personal loans often have rates ranging from 10% to 29%, while credit card interest rates can range from 15% to 30%.
Examples of secured debt include mortgage loans, auto loans, and certain secured credit cards. By contrast, many credit cards, personal loans, and private student loans unsecured and often come with relatively higher interest rates. The Consumer Financial Protection Bureau (CFPB) reports that credit card APRs have risen over the past decade, placing additional pressure on borrowers to pay down their balances quickly.
How Does a High Interest Rate Affect Your Finances?
High-interest debt can become challenging and negatively impact your financial well-being. First, high-interest rates can harm your credit score.
Often, people face unexpected hardships, such as job loss or injury, which prevent them from keeping up with payments and, in turn, harm their credit score. The larger your debt, the higher your interest rate will be, and the longer it will take to pay down what you owe to the lender.
High interest often compounded to the principal balance at the end of each billing cycle. For example, if you’re unable to pay off your credit card debt, interest can compound daily. This means high-interest credit card debt can build up quickly, making it increasingly difficult to manage if left unpaid. In fact, a 2023 study found that over 40% of Americans carry credit card debt from month to month, often accruing high interest in the process.
Moreover, unpaid high-interest debt can threaten your overall credit score. How you manage loans and your payment history play a crucial role in determining your credit score. If you find yourself unable to make payments, your credit score can suffer. Without realizing it, debt can increase your credit utilization ratio, which negatively affects your score.
Lenders typically recommend keeping your credit utilization ratio below 30%.
Since unchecked high-interest debt can quickly scale up, it’s essential to pay off these debts in a timely manner so they don’t impact your financial objectives. When you are unable to pay high-interest debts, it can often put you in stress, and shift you from your milestones of achieving homeownership or your family planning.
What’s the Best Way to Pay-Off High-Interest Debt?
If you’re wondering what’s the best way to pay off high-interest debt, here are a few strategies that you need to adapt and follow:
Start Making More Than Your Credit Card’s Minimum Payment
When you’re only making the minimum payment, your outstanding credit card balances can pile up quickly. To reduce your overall debt, you may want to avoid taking additional loans, as these will most likely cost you more interest in the long run. For instance, paying more than the minimum monthly payment on a $3,000 balance at 20% APR could help you save hundreds in interest over time. Therefore, to ensure you successfully pay off your loan, it’s best to diversify your work portfolio and increase your income. Your aim should always be to pay more than your credit card’s minimum each month.
Try to Adopt a Debt Avalanche Repayment Method
The avalanche approach is a payment method that targets high-interest debt. If you start with the avalanche method to pay off your compounding debts, it will prioritize paying off loan interest in descending order. It begins by paying off the highest interest debt first, then gradually moves to lower interest rates while continuing to make all pending payments on your credit account. This slow and steady method eventually reduces the amount of interest paid. A study by Northwestern Mutual found that using a structured repayment method like the avalanche approach helps borrowers reduce debt faster by focusing on high-interest accounts first.
Lastly, Consider Debt Consolidation
If you have several sources of debt and are unsure whether you can manage them, consider debt consolidation. This process involves combining different debts into a single loan, which you can then pay off in installments with lower interest. For example, consolidating credit card debt averaging 25% APR into a personal loan at 10% could save you substantial interest each month. Debt consolidation is ideal for those with multiple debts who may struggle to pay them off individually. Although there are many options for debt consolidation, we recommend doing thorough research.
When it comes to managing and repaying high-interest debt, you need to understand that it must remain consistent. Your objective should always be to put in your best effort and keep up with the minimum monthly payments. Pay more whenever you get the chance, or find ways to avoid getting into any new debts.
In fact, it’s a great idea to regularly check your credit reports.
This will give you a better understanding not only of your credit scores but also of your progress in the debt repayment process. You can access your credit report for free from various credit reporting agencies by signing up for an account. Many credit monitoring services offer a free monthly credit report and credit score, helping you stay informed about your financial health.
Ready to Take Control of Your High-Interest Debt?
Managing high-interest debt can feel overwhelming, but you don’t have to face it alone. Let Mountains Debt Relief offer you the best relief for your financial burdens. Whether you’re looking to consolidate, reduce your rates, or simply need guidance, our team is here to help you start your journey toward financial freedom.
Don’t let high-interest debt hold you back—get started today!