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Understanding and Managing High-Interest Debt

High-interest debt can significantly hinder your financial progress. When a substantial portion of your monthly payment goes toward interest, it can take longer to reduce the principal balance, and the accumulating interest can become increasingly costly. Below, we explore what high-interest debt is, provide examples, and offer strategies to 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, expressed as a percentage. Whether it’s a student loan, mortgage, auto loan, personal loan, or credit card, interest is typically charged on the balance until the debt is fully paid off.

Credit cards are notorious for their high interest rates. This type of revolving credit allows you to borrow up to a certain limit. As you pay down the balance, you can borrow again. However, if you don’t pay off the balance in full each billing cycle, you’ll incur interest charges.

Examples of High-Interest Debt

Interest rates can vary widely based on the type of loan and the lender. Your creditworthiness also plays a crucial role. Borrowers with less-than-perfect credit may face higher interest rates, as they are perceived as higher risk. 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: Personal loans for those with bad credit can have interest rates upwards of 30%, with some lenders offering rates in the triple digits.
• Payday loans: These short-term loans, designed for quick cash, often come with minimal credit requirements but extremely high interest rates and fees. According to the Consumer Financial Protection Bureau, APRs on payday loans can reach up to 400%, making even small loan amounts difficult to repay.

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 determine how much extra money you have each month after paying 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 monthly expenses or picking up a side gig to free up more funds.

2. Choose a Debt Repayment Strategy

There are several methods to pay off high-interest debt:

• Snowball method: Focus on paying off your smallest balance first, regardless of the interest rate. Once that debt is paid off, apply the money you were using for that payment to the next smallest balance, and so on. This method can provide small wins to keep you motivated.
• Avalanche method: Prioritize paying off the debt with the highest interest rate first. This approach can save you more money in the long run, although it may take longer to see progress.
• Debt consolidation: Combine multiple high-interest debts into one larger debt with a lower interest rate. This can simplify your payments and potentially save you money.
• Balance transfer credit card: Transfer your debt to a credit card with an introductory 0% APR. Aim to pay off the balance before the promotional period ends. Be aware of transfer fees, which are typically around 3% to 5% of the amount transferred.

3. Consider Credit Counseling

If you feel overwhelmed by high-interest debt, credit counseling might be beneficial. A credit counselor can offer personalized financial advice on debt repayment, budgeting, and saving. Nonprofit credit counseling is usually affordable. In some cases, a counselor may suggest a debt management plan, negotiating lower monthly payments and interest rates on your unsecured debt. This service comes with a fee, and you’ll need to close those debt accounts, but it may be worth considering.

The Bottom Line

High-interest debt is costly and can strain your monthly budget, making it harder to achieve your financial goals. The key is to get organized and create a plan to pay it off. Whether you take a DIY approach or seek help from a credit counselor, having a robust emergency fund can help you manage financial surprises without accumulating new debt.

For any mortgage-related needs, feel free to call O1ne Mortgage at 213-732-3074. We’re here to help you navigate your financial journey with confidence.

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