This is the third in a series of eight articles expanding on the steps of the article:
8 Steps to Build Wealth
Step 3: Pay Off High Interest Debt
Many people have found themselves in credit card debt that they can’t pay off for a while. I’ve even known people who have managed to dig themselves into debt, managed to pay it all off, and then bury themselves in debt once again after refusing to learn from their mistakes.
If you plan on building wealth, you need to permanently reign in your debt. You don’t have to completely eliminate your debt before building your assets, but you need to gain control of it. “Good” types of debt, such as student loans or mortgages, typically have low interest rates and therefore can be maintained for long periods of time as you build up your assets. It depends on your personality, though. Some people are more bothered by having a certain amount of debt than others. It’s typically a good idea under this scenario to work to increase your assets and decrease your liabilities at the same time. You’ll be building your investment experience and passive income while reducing debt in your life.
For high interest debt, however, the priority absolutely needs to be on eliminating the debt first. Interest rates for credit cards can far exceed even the best investments out there.
For context, consider that the typical long-term rate of return for the stock market is somewhere around 8-10% depending on exactly how you calculate it and how long of a time frame you use. In comparison, credit cards often have 15+% interest rates, and of course the rate spikes higher if you can’t pay. It makes far more sense to use your money to fight off the high rate of interest if you have credit card debt. Your total net worth will generally increase faster by using your money to pay off the high interest debts first. Plus, it’s difficult to be at ease with debt you don’t have control over, and mental ease is priceless.
{ 2 comments… read them below or add one }
It’s even worse — in after-tax dollars, the difference in rate between stock market returns and credit card interest is much higher because you are paying credit interest in after-tax dollars but the 8-10% stock market returns are before tax.
If you have a department store credit card charging 29.9% interest, you would have to make at least a 45-55% return on the same money in your investments!
Good point Glenn. Thanks for the comment.
{ 1 trackback }