Finances can be complicated to understand, but if you want to ensure you're living a financially healthy lifestyle, it's crucial to know whether you're making good long-term decisions. This is particularly true when it comes to managing debt.
The majority of Americans have at least one credit card. In fact, a Gallup poll found that only 29% of U.S. adults don't have any credit cards at all, while 7% of Americans have seven or more cards. And while credit cards can be healthy and help you achieve your financial goals, not understanding all their intricacies could lead to serious damage.
One of the most important features to understand about credit cards is the interest rate. Credit cards have notoriously high interest rates (the average being nearly 18% per year), and those interest payments can quickly skyrocket. However, nearly a third (30%) of Americans who carry credit card debt don't know what they're paying in interest, according to a survey from U.S. News & World Report.
Why is that a problem? Because high-interest debt can be incredibly toxic to your finances, and if you don't know what you're paying in interest, you could be spending far more than you realize.
Why high-interest debt is so harmful
The more high-interest debt you have, the more your interest payments snowball over time. If you only pay the minimum payments for years, depending on how much debt you have and your interest rate, you may not make any progress at all. Rather, your total balance may continue to climb even when you're making consistent payments.
Even if you do pay off the debt eventually, your total interest payments could equal or even outweigh your initial balance. For example, say you have $10,000 in credit card debt with an interest rate of 18%. If you're making monthly payments of $200, it will take roughly eight years to pay that debt off completely -- and you'll end up paying a total of nearly $9,000 in interest alone.
If you're saddled with high-interest debt but are unaware of exactly how much you're paying, you could end up spending tens of thousands of dollars over the years just in interest payments. Furthermore, if you continue racking up debt as you're attempting to pay off current balance, you'll likely end up stuck in a vicious circle, unable to completely knock out your debt.
Fortunately, even if you're drowning in debt, there are ways to overcome this challenge -- and the first step is to simply arm yourself with as much knowledge as possible.
Paying down debt one step at a time
Before you do anything, figure out what you're paying in interest. If you have multiple credit cards with different interest rates, this will help you decide where to focus most of your efforts. Start by paying down the debt with the highest interest rate -- even if it doesn't have the largest balance. By putting off paying down debt with the highest rates, your interest payments will only continue to climb.
Next, consider taking advantage of a balance transfer card. These types of cards allow you to transfer your credit card balance to a new card and take advantage of an introductory period where you'll pay little to nothing in interest. This gives you time to quickly chip away at your balance without the sky-high interest rate, and you can make a serious dent in your debt in a relatively short period of time.
Once you transfer your balance and enter the zero-interest introductory period, it's time to supercharge your savings. Do everything you can to pay off your balance before the introductory period ends (usually after 12 to 21 months), because after that time is up, you'll go back to paying a high interest rate.
After you've paid off your credit card with the highest interest rate, then tackle the card with the second-highest interest rate, and so on until all your credit card debt is paid off. In the meantime, do your best to avoid adding any more debt. If you're continuously adding to your balance, it will be tough to make any progress when chipping away at your debt.
Paying off debt isn't something that will happen overnight. It can take years to pay it off completely, but by being strategic about which debt to tackle first and exactly how to ensure your payments have the most impact, you can save yourself decades of work and thousands of dollars in interest payments.