The Impact of High-Interest Debt on Financial Health
Are you considering taking out a new high-interest loan or opening a credit card? Do you already have high-interest debt? In either case, you may be wondering how this debt can impact your long-term financial health.
Though it can be relatively easy to rack up a large amount of debt at a high interest rate, it may not be the best decision for your long-term financial picture. In fact, the cost in both time and money of this type of debt can have a devastating impact on your financial health.
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Read on to learn what that impact looks like, the different types of high-interest debt you should avoid and how to eliminate it as quickly as possible.
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How Does High-Interest Debt Impact Financial Health?
High-interest debt hurts your financial health for a few reasons.
First, it’s expensive. For example, say you had $10,000 in credit card debt with a 20% interest rate and the payments on that account were calculated as 1% of the balance plus interest. You would spend over $16,000 in interest on the account by the time you paid it off. That means your total interest cost would be over 160% of the total value of the original debt. So when you take on high-interest debt, you’re agreeing to a high cost of borrowing that equates to significant sums of money in the long run.
If you spend a significant amount of money on interest, you could be forced to make tough financial decisions when you get paid. You may have to forgo outings with friends and family or other luxuries because of the high cost of debt.
Perhaps the most important way high-interest debt impacts financial health is by limiting your investment abilities, which can have a profound impact on your long-term financial growth, especially if it happens early in life.
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Types of High-Interest Debt
Any type of debt can be a high-interest debt. Here’s a list of the types of loans that typically come with high interest rates.
Credit cards: These are usually unsecured lines of credit. You can spend up to your credit line and make monthly payments at the agreed-upon interest rate. But that rate may be high. In fact, according to LendingTree, the average credit card interest rate is over 24%.
Payday loans: These short-term loans may seem relatively inexpensive, but that’s not usually the case. The typical fees and interest on a payday loan can equate to a 400% interest rate.
Personal loans: Banks provide these on either a secured or an unsecured basis. While the average interest rate on a personal loan typically ranges from 7% to 36%, per Forbes, the actual interest you will pay ranges based on a number of factors, such as your income and debt-to-income ratio.
Auto loans: These are secured lending products, meaning that if you don’t make your payments, the bank can repossess the vehicle. That limits risk, leading to lower interest rates than what you’d find on the loans above in most cases. However, some auto loans, specifically those that market to consumers with poor credit, come with high interest rates. So make sure you shop around before you agree to any rate.
Ways To Eliminate High-Interest Debt
If you already have high-interest debt and want to get out of it, you’re not alone. Per the Federal Reserve, the total credit card balance of Americans in the second quarter was $1.14 trillion. But you don’t have to deal with that debt forever. Here are a few ways to eliminate your high-interest debt.
Get Creative With Your Payments
One option to get out of debt faster is to get creative with your payments. For example, you could use the debt snowball or debt avalanche payment method. You’ll make minimum payments to all but one account with both methods. With the snowball method, you’ll dedicate all extra payments you can make to the card with the lowest balance. With the debt avalanche method, you’ll direct all extra payments to the card with the highest interest rate.
Once you pay off the first target account, you move to the next one. The debt snowball method works by helping you celebrate little wins to keep you motivated to pay your debts off. The debt avalanche method works by focusing on your most expensive debts first, regardless of the size of the balance.
Consolidate Your Debt
You may also be able to consolidate your debts to reduce your interest cost immediately. Consider looking into debt consolidation loans or consider using a home equity loan to pay off your high-interest debt at a significantly lower rate. But keep in mind that if you choose the latter, you’ll be using your home as collateral. So that should be an option only if you’re absolutely sure you can afford the payments.
Take Advantage of a Debt Management Plan
If you’ve decided that it’s not worth managing your debt on your own or that you simply need help, consider reaching out to a debt management company. These companies are usually nonprofits that may be able to help you reduce your interest rates and monthly payment obligations.
Settle Your Debt
If you’re deep in debt and none of the above options offers enough relief, consider enrolling in a debt settlement program. These programs attempt to negotiate the amount of debt you owe with your lenders, which may significantly reduce the financial burden your debt represents.
On the other hand, settlement typically comes with significant credit implications and may have tax implications. So this should be considered only as a last resort.
File Bankruptcy
Nobody wants to think about bankruptcy as a debt relief option, but it’s necessary in some cases. Some experts say that if you have reached out for help and still can’t pay your debts off within three years, you should consider bankruptcy. However, this can be a tough decision that’s worth chatting about with a bankruptcy attorney first. And you should be aware of the financial implications this can cause, like the impact on your credit score.
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This article originally appeared on GOBankingRates.com: The Impact of High-Interest Debt on Financial Health