When you hear the word “investment,” your mind probably goes to stocks and bonds. But the best way to get a return on investment is by paying off consumer debt. NerdWallet found in its annual report on consumer credit cards that 18% said rising interest rates had made debts more costly. You can’t know what the market will do this year. But paying down high-interest credit card debt is a sure way to get a good return on your investment.
According to the Federal Reserve Bank of St. Louis, as of February 20, 2023 the average rate of interest on credit cards was 19.92%. This means that for each dollar you repay, you will save 21 cents in interest over the course of a year. It may seem insignificant, but paying off $5,000 in credit card debt would save you more than $1,000 on interest. The return of 21% on money is five times higher than what you could earn from a high interest savings account.
There are four ways to reduce your debt and increase the return on investment.
1. If possible, stop adding debt.
Interest on credit cards is calculated using your daily average balance. If you are paying off your credit card balance, but using it for other expenses as well, you may be just treading water. Your payments go to interest and not towards reducing your debt.
It’s a smart idea to switch from credit cards to debit or cash, at least temporarily. You might lose out on rewards, but paying high interest will eat up the rewards. You might want to use credit cards once your debt has been paid and pay them off in full every month. This will avoid paying interest.
2. Look for lower-interest alternatives
By lowering the interest rates on your debt, you can pay less in interest while paying more towards the principal.
You may be able to lower your rate if you have good credit. In the survey, 15 percent of Americans said they used a credit card balance transfer to reduce their interest rate. Balance transfer cards offer a low-interest rate for a limited time — usually 15-18 months — in exchange for a small fee. A balance transfer card will charge you between 3% and 5% on the transferred amount. If it takes you some time to repay your debts, it is worth the cost.
A consolidation loan may offer a better interest rate. Rates on loans have been increasing as well, but you may be able to get a better deal if you’re able to pay a monthly fixed payment and have a good credit rating.
3. Now is the time to reduce your savings and investments.
You can get 20% ROI if you pay off your credit card debt. This is a very high rate of return, which would be difficult to duplicate in the stock markets in the same period. You might consider putting off investing until you can pay down your debt.
This rule is not absolute. It makes sense, if you are contributing to a workplace account (such as a retirement 401(k), with an employer matching contribution, to keep on doing so until the match is complete. This is free money, and it’s likely to be a higher return than 20%. However, you will need to check the details of your employer’s matching policy.
Savings can be used to temporarily cut costs. You’ll be in the red if you earn 4% in a high yield account and pay 20% on your debt. You may not require the three to six month’s worth of savings to begin paying off your debt. Consider starting an emergency fund to cover one-month’s expenses. Then, set up regular transfers to your savings while directing the bulk of your surplus cash towards debt repayment.
In the worst-case scenario you may have an unexpected emergency and need to use your credit card. In the interim, paying down that balance will save you a ton of money in interest.
4. Supercharge debt payoff
You’ve decided to stop using your credit cards, have looked into lower-interest options, and are reducing savings and investments (for the time being). It’s now time to go through your budget and find any other ways you can cut expenses so that you can pay more towards your debt. Cut back (or eliminate) non-essential purchases. You can spend on nonessential items guilt-free and increase your savings and investments as soon as you have paid off your debt.