Personal Finance Insider writes about products, strategies, and tips to help you make smart decisions with your money. We may receive a small commission from our partners, but our reporting and recommendations are always independent and objective.
- Financial planners often recommend paying off “high-interest debt” before saving or focusing on other financial priorities.
- But which debts should you pay off before saving, and which can you continue to pay while you save?
- Some experts say any loan above student loan or mortgage interest rates is high-interest debt, a range of about 2% to 6%.
- Things like personal loans and credit card debts have much higher interest rates, ranging from 9% to 20% or more.
- To determine whether your debt is high-interest, it might be worth comparing the interest rate to how much it could earn if it was invested.
- Sign up for Personal Finance Insider’s email newsletter here »
If you’ve ever googled a question like “should I pay off debt or save for retirement?”, you’re 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 does that mean exactly? Which debts should be tackled aggressively and which can be paid off over a longer term?
Understanding your interest rate
Every loan has a different interest rate set by the lender. The interest rate of your debt determines how much it will ultimately cost to borrow the money, and it can also influence how quickly you pay it off and prioritize your other saving and investing goals.
Generally, high-interest debt should be paid off sooner rather than later — while there’s probably no rush to pay off your mortgage with a 3% interest rate, your credit card carrying a 20% interest rate should be a pay-off priority.
But, financial planners say that there’s no one solid number that defines a high-interest debt in every scenario. Interest rates are always changing, and everyone has a different tolerance for debt, which can make that figure a very personal one that’s constantly in flux.
Knowing whether or not you have high-interest debt is important for determining your priorities, such as which debt to pay off first and whether or not to save or invest. While there’s no one solid number that indicates a high-interest debt, there are two indicators you can look out for.
The interest rate is higher than interest rates for mortgage loans or student loans
“Some folks say that any debt in double digits is expensive debt. Others say anything above student loan or mortgage debt [is high-interest],” says financial planner Marguerita Cheng of Blue Ocean Global Wealth.
Mortgages tend to have interest rates around 3%. Student loan interest rates can be slightly higher — for the 2020 to 2021 school year, federal student loan interest rates will range from 2.75% to 5.3%.
Credit card and other unsecured loan debt tends to have interest rates higher. The average personal loan interest rate is 9.63%, while the average credit card has a 14.52% interest rate.
Comparing interest rates on credit cards and personal loans to necessary debt like student loans or mortgages can help put debt into perspective.
“In this context, both a private student loan with a 12% interest rate and a credit card with a 22% interest rate are high-interest debt — and far too high to carry longer than necessary,” says Kevin Mahoney, a financial planner and founder of Illumint.
The interest rate is higher than what you could earn by investing or saving it
When talking about high-interest debt with his clients, Mahoney says that there’s more to the story than just the loan’s interest rate — it should also be about what your money could be earning if it was invested or saved.
The S&P 500 is a major stock market index, and investors use it to measure what investing could yield. Mahoney says that historic average stock market returns could be a good guide for what’s considered high-interest debt.
“We also often have a conversation about how the S&P 500, when adjusted for inflation, has returned just under 7% on an annual basis since 1928,” he tells Business Insider by email.
Mahoney adds, “Using our money requires trade-offs. When a particular source of debt carries an interest rate that significantly exceeds the other ways in which you could use your money, it’s a debt and an interest rate that you probably want to pay off as soon as possible.”
Disclosure: This post is brought to you by the Personal Finance Insider team. We occasionally highlight financial products and services that can help you make smarter decisions with your money. We do not give investment advice or encourage you to adopt a certain investment strategy. What you decide to do with your money is up to you. If you take action based on one of our recommendations, we get a small share of the revenue from our commerce partners. This does not influence whether we feature a financial product or service. We operate independently from our advertising sales team.
Personal Finance Insider offers tools and calculators to help you make smart decisions with your money. We do not give investment advice or encourage you to buy or sell stocks or other financial products. What you decide to do with your money is up to you. If you take action based on one of the recommendations listed in the calculator, we get a small share of the revenue from our commerce partners.