Debt and Compound Interest: When Compounding Works Against You

So far we've talked about how compounding helps you build wealth. But compounding is a double-edged sword—it can work against you with debt.

How Debt Compounds

Just as your investments earn interest on interest, debt grows the same way. This is why credit card debt becomes such a problem so quickly.

Example: $5,000 credit card balance at 19.9% APR (typical rate) - Month 1 payment (minimum ~2%): $100 - Interest charged: $83 - Principal paid down: $17 - Month 2 balance: $4,917 - This cycle continues...

If you only make minimum payments, you'll be paying interest on interest, and it will take years to pay off.

Credit Card Debt: The Worst Case

Credit card debt is particularly damaging because: - **High interest rates**: Usually 15-25% APR - **Compounding daily**: Interest is calculated every single day - **Minimum payments are small**: Only 1-3% of balance - **You're primarily paying interest**: Especially early on

$5,000 at 19.9% with minimum payments: - Time to pay off: ~6 years - Total paid: ~$7,400 - Interest paid: ~$2,400 (48% of original debt!)

Mortgage Debt: A Better Kind

Not all debt is equal. Mortgages are generally more favourable: - **Lower interest rates**: Usually 3-7% compared to credit cards - **Longer repayment terms**: 15-30 years allows slower payoff - **The asset appreciates**: Unlike credit cards, you own an appreciating home

Of course, it's still preferable to minimise debt.

Student Loans: The Middle Ground

Student loans typically have: - **Moderate interest rates**: 4-8% depending on loan type - **Longer repayment periods**: 10-25 years available - **Possible income-based repayment** - **Potential interest deductions**

Strategies to Combat Debt Compounding

**1. Pay More Than Minimums** Paying just $50 more per month on that $5,000 credit card debt cuts the payoff time in half and saves over $1,000 in interest.

**2. Highest Interest First** If you have multiple debts, pay minimums on all, then put extra toward the highest rate debt first.

**3. Consolidation** Moving high-interest debt to a lower-rate option can save thousands.

**4. Balance Transfers** Some cards offer 0% introductory rates—use this to pay down principal quickly.

**5. Avoid New Debt** While paying off existing debt, avoid accumulating new high-interest debt.

The Takeaway

If you're paying high-interest debt, your first priority should be eliminating it. The compounding works against you, and every month you wait, it gets worse. Use our Debt Payoff Calculator to see exactly how long it will take and what extra payments could save you.