What is high interest debt?
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- Financial planners often recommend paying off “high-interest debt” before saving or focusing on other financial priorities.
- But what debts do you need to pay off before you save, and which ones can you keep paying while you save?
- Some experts say that any loan that is higher than student loan or mortgage interest rates is high interest rate debt, in the range of about 2% to 6%.
- Things like personal loans and credit card debt have much higher interest rates, ranging from 9% to 20% or more.
- To determine if your debt is at a high interest rate, it may be helpful to compare the interest rate to the amount could win if invested.
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If you’ve ever Googled a question like “should i pay off my debt or save for retirement?You are not alone. Many have wondered which financial priority to tackle first.
Financial planners often recommend paying off “high interest debt” before focusing on other financial goals, like saving, but what exactly does that mean? Which debts need to be aggressively tackled and which can be repaid in the longer term?
Understanding your interest rate
Each loan has a different interest rate set by the lender. The interest rate on your debt determines how much it will ultimately cost you to borrow money, and it can also influence how quickly you pay it off and prioritize your other savings and investing goals.
As a general rule, high interest debts should be repaid as soon as possible. While there’s probably no rush to pay off your mortgage with a 3% interest rate, your credit card with a 20% interest rate should be a priority for repayment.
But, financial planners say there isn’t a single solid number that defines high interest debt in every scenario. Interest rates are constantly changing and everyone has a different tolerance for debt, which can make this number a very personal and ever-changing number.
Knowing whether or not you have high interest rate debt is important to determining your priorities, such as which debt to pay off first and save or not or invest. While there isn’t a single solid number that indicates high interest rate debt, there are two indicators you can look for.
The interest rate is higher than the interest rates on mortgages or student loans
“Some people say that any double-digit debt is expensive debt. Others say anything above a student loan or mortgage debt [is high-interest], says the financial planner Marguerita Cheng of Blue Ocean Global Wealth.
Mortgages tend to have interest rates around 3%. Student loan interest rates may be slightly higher – for the 2020 to 2021 school year, Federal student loan interest rates will vary from 2.75% to 5.3%.
Comparing interest rates on credit cards and personal loans to necessary debts like student loans or mortgages can help put debt in perspective.
“In this context, a private student loan with an interest rate of 12% and a credit card with an interest rate of 22% are debt with a high interest rate – and far too high to be carried over. long as needed, ”says Kevin Mahoney, a financial planner. and founder of Illuminate.
The interest rate is higher than what you could earn by investing or saving it
When discussing high interest rate debt with his clients, Mahoney says it’s not just the loan interest rate in the story – it should also be about what your money is. could pay off if it was invested or saved.
The S&P 500 is a major stock market index, and investors use it to measure what the investment might earn. Mahoney says historical average stock returns could be a good guide to what is considered high interest debt.
“We also often have a conversation about how the inflation-adjusted S&P 500 has returned just under 7% year on year since 1928,” he told Business Insider via e- mail.
Mahoney adds, “Using our money requires compromise. When a particular source of debt carries an interest rate that far exceeds other ways you can use your money, it’s a debt and an interest rate that you probably want. repay as soon as possible. “