Rising Interest Rates Make Debt Payoff a High-Reward Investment
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The word “investment” likely brings to mind stocks and bonds, but the best return on your money might be obtained by tackling consumer debt. NerdWallet’s annual consumer credit card report found that 18% of Americans say rising interest rates have made their overall debt more expensive. While you can’t predict what money invested in the stock market will make this year, paying off high-interest debt provides you with a guaranteed bang for your buck.
As of February 2023, the average interest rate on credit card accounts charging interest was 20.92%, according to the Federal Reserve Bank of St. Louis. That means for every dollar of debt you pay down, you’d save about 21 cents over the course of the year. That may sound inconsequential, but if you paid off $5,000 worth of credit card debt, that would result in more than $1,000 in interest savings. A 21% return on your money in a year is about five times what you might earn in a high-interest savings account.
Here are four steps to pay off your debt sooner and maximize that ROI, or return on investment.
1. Stop adding to debt, if possible
Credit card interest is calculated based on your average daily balance. So if you’re making payments toward your balance but still using the card for expenses, you might just be treading water. Interest keeps accruing, and your payments are going toward interest rather than meaningfully reducing the debt.
Switching to cash or debit — at least in the short term — is a good idea when you’re paying down credit card balances. Sure, you might miss out on credit card rewards, but if you’re paying sky-high interest, the rewards are being eaten up and then some. Once your debt is paid off, you might consider using credit cards again and paying them in full each month to avoid interest charges.
2. Seek out lower-interest options
Lowering the interest rate on your debt means that less of what you pay goes to interest and more goes toward wiping out the principal balance.
If you have a good credit score, you may have options to reduce your rates. According to the survey, 15% of Americans say they’ve used a balance transfer credit card to save on rising interest rates. Performing a balance transfer can provide you with a short-term 0% interest rate — often 15 to 18 months — for a fee. The fee is usually 3% to 5% of the balance you’re transferring; if it’s going to take you a while to pay off your debt, the fee is probably worth it.
You might also find a consolidation loan that offers a lower interest rate than you’re paying now. Loan rates have also been rising, but if you have good credit and need a longer timeline than a balance transfer card will give you, it could make sense to seek out a loan and make a fixed monthly payment for a specified period of time.
3. Consider pulling back on savings and investing, for now
When you have credit card debt at 20% interest, you effectively get a 20% annual ROI when you pay it down. That’s a high return that could be hard to replicate in the stock market in the same time frame. So for now, you might want to pause investing to attack your debt.
There are exceptions to this. If you have a workplace retirement account — such as a 401(k) — with an employer match, it makes sense to continue contributing enough to capture the full match. That’s free money and likely equates to a return higher than 20%, though you’ll need to look at the specifics of your company’s match policy.
Contributing to savings may be another place to cut back temporarily. Earning 4% interest in a high-yield account while paying 20% interest on debt leaves you in the hole. While it’s smart to have an emergency fund, you may not need the recommended three to six months’ worth of expenses saved before you start tackling your debt. If you feel that your job is secure, consider starting with an emergency fund that will cover one month of expenses, then set up a small recurring transfer to your savings account while allocating the majority of your excess cash to debt payoff.
Worst-case scenario, an emergency comes up and you have to put it on your credit card. But in the meantime, you’ve saved a lot of interest by paying that balance down.
4. Supercharge debt payoff
OK, so you’ve stopped using your credit card, looked at lower interest options and reduced savings and investing (for now). Now it’s time to scour your budget for any additional ways to cut costs so you can put even more money toward your high-interest debt. Consider cutting back on (or cutting out entirely) your nonessential purchases. The sooner you pay off your debt, the sooner you can add back nonessential spending guilt-free — and ramp your investing and savings back up — without the stress of interest eating away at your finances.
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