There is a subset of people that are very comfortable with their debt. Even if it’s high-interest debt, like what you see with credit cards, they are comfortable with it. That’s because it is “affordable” for now. However, before you get too comfortable with high-interest debt, it’s a good idea to step back. Your finances might be in better shape if you tackle this bad debt, getting rid of it once and for all. Here are 3 reasons getting rid of high-interest debt is a good idea.
1. It Doesn’t Usually Provide You With a Future Return
In most cases (but not all), high-interest debt is associated with consumer spending. When you only pay the minimum payment on your high-interest debt, you stretch out how long you are paying for those consumer items. The problem with taking years to pay for consumer items is that you end up with diminishing returns for your efforts. You pay more over time, but the value of the item goes down.
This isn’t the case with many low-interest debts. A case can be made for mortgages, business loans, and student loans. These low-interest loans often (but, again, not always) represent investments in your future. What you get back has the potential to return more than you borrow and pay in interest. This is rarely the case with consumer items bought with high-interest credit cards.
2. You Usually Can’t Deduct the Interest You Pay
The interest you pay on credit card debt doesn’t come with a tax benefit. You just pay the money into someone else’s pocket. With a low-interest loan, like a mortgage or student loan, and even some business loans, you might be able to deduct the interest (you may have to itemize to get this benefit).
As a result, even though it’s still debt, at least a low-interest loan made for many so-called “good” purposes probably comes with a tax benefit. This is just another reason to pay off high-interest debt before you move on to low-interest debt.
3. Your Investment Returns Probably Won’t Overcome High Interest Rates
Many of the folks I know who are content with their debt levels are investing. They invest their money in taxable and tax-advantaged accounts, even as they pay 19.99% APR on their credit cards. There is no way that their investment returns are going to overcome that interest rate. From 1926 to 2012, the annualized return for the S&P 500 was 9.82%. That basically amounts to a 10% loss annually.
You have a reasonable chance of beating low-interest debt with your investment returns. If you get a tax benefit for your low-interest debt, and you have a tax benefit for the investments you make, the chance of overcoming what you spend on your low-interest debt increases. This just isn’t going to happen if you have high-interest debt, because high-interest consumer debt doesn’t come with any of the possibilities that mark low-interest debt that is considered “non-consumer.”
As you consider which debts to pay off, and whether or not it’s worth it to pay off debt, don’t forget to consider the various attributes of the debt you have. It might make sense to invest instead of paying off your mortgage early, but it almost never makes sense to pay off your high-interest debt slowly.