A recent report found that the average credit card interest rate was 20%! How can anyone pay off their debts when one-fifth of their payment goes to interest alone? Here are a few ideas.
Why are interest rates so high?
The Federal Reserve ("The Fed") is the central bank in the U.S. that determines interest rates that banks use for certain products. When inflation rises, the Fed will increase interest rates to curb spending and lower demand for borrowing money, reducing inflation. The good side is that interest rates will also increase in interest-bearing accounts like savings and money market accounts, giving consumers another reason to save their money.
On the other hand, when inflation is low, and supply is high, the Fed will lower interest rates to entice people to borrow money and put more cash into the economy. If you've ever heard the phrase "money is cheap now," it's because interest rates are low.
Thanks to economic conditions caused by the Russian invasion of Ukraine, COVID-19, and supply chain issues, inflation is hitting record highs globally. Consequently, the Fed is raising interest rates quickly, and banks are following suit, raising market rates on credit cards and variable loans.
How to pay off debt when interest rates are high
Despite record-high interest rates, there are still things you can do to get out of debt. First, keep an eye on your credit report at all times. You'll rarely need to pay to check your credit score as there are many apps and sites that will do "soft" pulls on your report. In addition, the three major credit reporting bureaus all offer one full credit report a year for free.
Next, make a plan for how you'll knock out your debt. There are several popular methods for debt reduction that have good results:
The Snowball Method - Make minimum payments on all debts but put all "extra" funds towards getting rid of your smallest debt first. Once that's paid off, move on to the next lowest debt, and so on.
The Avalanche Method - Make minimum payments on all debts but focus on getting rid of the debt with the highest interest rate first, regardless of your balance. Once that debt is paid off, move on to paying off the debt with the next highest rate, and so on. This method saves money in the long run but is harder to stick to if you need quick wins to stay motivated.
Consolidation - Instead of dealing with multiple payments, consider using a consolidation loan. Consolidating your debts will put all balances under one loan or credit card so that you only have to make one monthly payment, allowing your money to go further. This type of debt relief is a great way to get rid of debt but should only be used if you can stay disciplined and not use your newly-available credit balances to get back into debt by spending frivolously. You should also be aware that this method of debt relief may affect your credit depending on if it's a new loan or credit card you're getting.
The bottom line
Regardless of which method you decide to use, getting rid of your debt should be a priority this year so that you don't end up paying record-high interest rates on purchases you've already made. The sooner you make a plan and stick to it, the less you'll have to worry about what the Fed's decisions are doing to your financial health.
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