What Is High-Interest Debt?
All debt has interest, but there are huge differences between high-interest debt, like credit cards, and low-interest debt, like mortgages.
December 21, 2021
Every time you borrow money, you will pay interest to the lender. Charging interest is how these lenders make money — without it, they would have no reason to issue loans. However, there is a massive variety in the interest rates that are charged for different types of debt.
Some mortgages and auto loans could be as low as 2% interest, while high-interest debt like credit cards could carry interest rates of up to 36%. And it could be worse: Some payday loans can carry annual interest rates of up to 664%, according to data from the Center for Responsible Lending.
In this article, we’ll focus specifically on explaining debt with a high interest rate and showing how these high rates can affect your wallet.
High-interest debt defined
There is no firm definition for what qualifies as a high interest rate. However, some experts define it as any rate above 6 to 8 percent.
Many experts define high-interest debt as any debt with a higher rate than what “good debt” loans offer. Good debt includes low-interest loans like mortgages and federal student loans.
Average mortgage rates are quite low — around 4% — but can range up to 7.8% for some buyers. The average student loan interest rate is around 5.8%.
Although there is no formal definition for high-interest debt, for our purposes we’ll define it as any debt that carries an annual interest rate of more than 6 to 8 percent.
What products carry a high interest rate?
Let’s look at the average interest rates in a few product categories to get a better idea of where high-interest debt comes from. Generally, any rate above these average rates could be considered high interest.
These categories are listed in order of highest to lowest average interest rate.
Payday loans: Payday loans charge interest in a different way, which is usually not expressed in annual percentage rate (APR). Rates vary substantially from state to state. See this map for average interest rates in your area.
Credit cards: The average credit card interest rate is around 18% for new offers, while existing accounts average around 14.5%.
Personal loans: The average personal loan interest rate is around 14.5%, although this varies substantially depending on the loan duration and the borrower’s creditworthiness.
Student loans: The average student loan interest rate is around 5.8%.
Mortgages: The average mortgage interest rate for the most common mortgage, a 30-year fixed mortgage, is around 4%.
What high-interest debt means for your finances
We’ve defined what high-interest debt is, but what does it actually mean for your wallet?
If you have high-interest debt
If your credit card balances are getting higher and higher, or you haven’t paid back a personal loan, it’s a good idea to make it a priority to pay off any of these high-interest loans as soon as possible.
A couple popular methods you could use are the debt snowball and the debt avalanche methods. The former works by paying off the smallest balances first, and the latter by paying off the highest-interest debt first. Choose the one that works best for you.
If you don’t tackle this high-interest debt, it could continue growing and weighing on your finances for years to come.
If you don’t have any high-interest debt
If you’ve got a clean slate when it comes to debt — or you only have lower-interest loans — you’ll want to focus on avoiding additional debt wherever possible.
While it’s a good idea to avoid debt in general, avoiding higher APR financial products like personal loans and credit cards will have the biggest impact.
It could affect your investing strategy
We are all told that investing is important, and this is certainly true when it comes to building wealth. However, if you have high-interest debt, it may make more sense to pay it off before investing.
In the long run, the stock market tends to produce returns of around 10% per year. If you have debt that’s charging you 15%, 20% or more, then the smarter financial move would be to pay off the debt first, and then start investing.
There are some exceptions to this rule, however. See our investing order of operations guide for more information.
Consolidating or refinancing high-interest debt
In some cases, it may be possible to consolidate debt — meaning merging several debts into one new loan — or to refinance debt to hopefully get a better interest rate. This can be done through your bank or credit union, or through an online lender.
This strategy makes the most sense for those whose credit rating has improved since taking on the debt. For instance, you may have had a poor credit score when you first got a credit card; if you have a balance on this card, it’s likely at a very high APR. If you refinance your credit card debt, you may be able to get a lower rate.
Consolidating can also simplify your financial situation by taking several different loans — each with their own due dates, APRs and terms — and combining them into one.
For credit cards, a great way to consolidate debt is with Tally†. Tally is an app that helps you manage your high-interest credit card debt in one place — and it can potentially help you save money on interest and get out of credit card debt faster.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.