Why You NEED To Pay Off High Interest Debt

Credit Card debt is one of the most financially irresponsible things I think one can do!  I like to think people just don’t know how stupidly high of a rate you’re paying for that money rather than that people can’t control themselves.  I can’t tell you how to pay off your credit cards, but I sure can tell you why you should!

Compound Interest Working Against You

Remember that thing called Compound Interest?  It’s earning interest on your interest and is an amazing thing, but only if it’s working to make you money! When you are in debt, it’s working against you especially credit cards that have an APR of like 16%-20%!

You have a $1000 credit card debt accruing 18% interest. If you just pay the minimum of $20 a month, you’re next month balance will be like $995.  You might just be like “ok, whatever.”  If you closely inspect it, you’ll realize you paid $20, but your balance went down by $5, so they charged you $15, not the end of the world…

But if you continue to pay the minimum and step back and look at the big picture over the long term you will have paid an extra $862.18 worth in interest to pay it off.  To me that’s a HUGE amount relative to the principle of $1000.  Basically you’re giving the credit card company an 18% return on their investment (so long as you’re still paying)!

Comparing APRs

As an investor, it’s damn near hard to find a investment that will return 18% a year. Also it’s basically impossible to do it consistently over many years.  But having and paying off credit card debt is like getting an 18% return on your money!

Let’s say you’re $1000 in debt on a credit card and you come into $500.  If you choose to “invest” that $500 on your debt, you just saved having to pay 18% APR on $500.  This can kinda be seen as you’re getting(saving) 18% APR on $500 worth.  That’s a great return and you should take it!  Also it’s a guaranteed amount of savings as opposed to investments are more volatile.

If you’re in debt at a low APR such as 3%, then paying off this debt might not be the most financially savvy move.  If you can earn like 10% investing elsewhere like the S&P 500, then it might be better paying off that loan slower.

The Human Condition

If you get a satisfaction of being debt free then maybe paying off a lower debt loan might be what’s good for you.  I carry a 3.75% mortgage, but I chose to pay off a 2.875% student loan debt.  Both those are low and the student loan was at an even lower APR, but I was just sick of looking at it and closed it out with a one time $7000 payment.

Also I personally never had any control issues with credit cards.  They are an amazing thing for financially responsible people.  They offer waaaay better fraud protection over using a debit card, they offer points/rewards, provide online purchases, membership benefits, and and buyer protection. I love my credit cards, but I never carried a balance.  i guess I just was too pragmatic when it comes to paying extra costs.

I have encountered people who generally have less control over their spending and honestly it’s often times more because of the lack of funds rather then extraordinary spending.  I think you just have to be wary of your spending and learn to cut costs to live within your means.  That’s another topic for another day though.

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