What is considered high-interest debt?

What qualifies as high-interest debt?

There’s no official definition of what qualifies as high-interest debt. Still, in general, any debt with an interest rate of 10% or higher is considered high-interest debt. The interest rate charged on your debt is a percentage of your total balance. The rate is expressed as an annual percentage rate (APR) — meaning how much interest is charged over one year.

For example, if you have a debt with a $10,000 balance and an APR of 10% — you’ll end up paying $1,000 in interest over a one-year period if your balance remains the same.

In contrast, low-interest debt offers rates below 10% APR, and sometimes as low as 5% APR or lower — depending on the loan. These debts are sometimes considered “good debt” and offer low rates when borrowing for a home, car or student loan.

Examples of high-interest debt

• Credit cards: Credit cards are a type of revolving debt that usually comes with a very high interest rate. As of publishing, average interest rates are around 21% to 28% APR.
• Personal loans: Personal loans are a type of unsecured loan with fixed repayment terms and interest rates. If you don’t have the greatest credit score, some personal loans charge interest rates of up to 35% APR.
• Payday loans: These loans are structured in a way that pays off the loan with your next paycheck — but come with extremely high fees and rates. Some payday loans can charge in excess of 200% APR, making them difficult to pay off.
• Some auto loans: Dealerships that offer “zero down” and “no credit check” auto loans may charge 15% APR or more as part of in-house financing at car dealerships.

How does high-interest debt affect your finances?

High-interest debt can put a strain on your monthly budget — forcing you to pay more money toward interest than the principal balance of your debts and making your debt payments very high. High-interest debt can also compound in some cases, making it much harder to pay off your debts.

For example, credit card interest can get added to your card balance if you only make the minimum payments. This means your credit card balance actually goes up while you’re still making payments. This is known as “negative amortization” and can massively hurt your finances.

If you end up with a lot of high-interest debt and are having a tough time paying it off, this can eventually hurt your credit score as well. Having a high debt-to-credit ratio can lower your score, and if you miss any payments, it can knock your score down quite a bit.

Ultimately, holding high-interest debt is stressful. It can weigh on you emotionally and make it difficult to handle the day-to-day of your finances. You may end up further in debt just trying to get by — which can lead to higher payments and eventually bankruptcy.

Strategies to manage high-interest debt

High-interest debt can be stressful, but there are strategies that can help you pay it off. Here are a few methods you can use to tackle your high-interest debts and even lower your rates and monthly payments.

• Debt snowball or avalanche method: Paying off your debts faster requires a debt payoff plan. The debt snowball has you focus on paying off the smallest balance debt first, while the debt avalanche has you pay off the highest interest rate debt first. Both methods help you pay off debt by paying the minimum payment on all debts except the one you focus on paying off quickly. This builds momentum and helps you pay off the remaining debts faster.
• Balance transfer: A balance transfer credit card allows you to move multiple credit card debt balances onto a single card. Balance transfer cards usually offer a low introductory APR for a set period of time — such as 0% APR for 15 months. This can help you lower your monthly payments and pay down your credit card balances faster. Just make sure to calculate the balance transfer fee — usually 3% to 5% of your total balance transferred.
• Debt consolidation: A debt consolidation loan can help you combine multiple debts into a single loan and monthly payments. In many cases, debt consolidation loans help lower your interest rate and make your payments more manageable. A debt consolidation loan can be a personal loan or something like a home equity line of credit (HELOC). Lower rates and payments mean you can pay off your debt balances more quickly.
• Credit counseling: Credit counseling agencies are nonprofit organizations that help you come up with a debt payoff plan — and can even negotiate payments with your creditors. They start by helping you create a budget and then negotiate payment plans with each creditor on your behalf. This can help you get caught up on your debt payments and pay off debt at your own pace.

Alternatives to high-interest debt

Sometimes, high-interest debt might seem like the only option to help you make a purchase. But there are alternatives. Here are a few ways to obtain a low-interest loan or to avoid high-interest debt altogether.

• Home equity loans. Home equity loans allow you to borrow against the equity in your home. These loans or lines of credit usually come with low interest rates and more manageable monthly payments.
• No-interest credit cards: If you need to use a credit card for a major purchase, get one with an introductory 0% APR. There are cards that offer 0% rates for up to 21 months, allowing you to pay off your purchase without paying any interest at all. Just make sure you have a plan to pay off your debt balance or you may end up paying a high rate later.
• Savings buckets: You might be able to avoid debt altogether if you save for larger purchases ahead of time. Yes, I know this sounds easier said than done. Still, planning out future purchases and adding to your budget now means the money will be there when you need it. For example, if you have a planned vacation next year and it will cost $3,600, you can set aside $300 each month for 12 months to pay for it. You avoid credit card debt and won’t pay any interest at all.