Debt is not inherently good or bad. It is a tool with costs attached. The question is not whether debt exists, but what it costs, and how that cost compares to the alternatives.
This article explains why interest rate is the central variable in thinking about debt, how high-interest debt interacts with investment returns, and why addressing certain debts before investing often makes mathematical sense.
This is general educational information, not personal financial advice.
The Core Concept: Interest Rate as Cost#
When you owe money, the interest rate determines how much that debt costs you over time. A $10,000 debt at 5% annual interest costs $500 per year to carry. The same debt at 20% costs $2,000 per year.
This seems obvious, but the implications compound. High-interest debt does not just cost more. It grows faster. And if you are only making minimum payments, the balance can stay stubbornly high while the interest keeps accumulating.
The practical effect is that high-interest debt can quietly consume a large portion of cashflow, leaving less available for everything else, including investing.
The Mathematics of Comparison#
One way to think about debt repayment is as a guaranteed return. If you pay off debt charging 20% interest, you have effectively "earned" a 20% return on that money, because you are no longer paying that cost.
Compare this to investing. Historical long-term returns for diversified share portfolios have averaged roughly 7 to 10% per year, depending on the period and how returns are measured.¹ These returns are not guaranteed. They come with volatility, uncertainty, and the possibility of loss in any given year.
The comparison becomes stark:
| Option | Expected Return | Certainty |
|---|---|---|
| Pay off 20% debt | 20% | Guaranteed |
| Invest in diversified shares | 7-10% (historical average) | Uncertain, variable |
When the guaranteed return from eliminating debt exceeds the uncertain return from investing, the mathematics favour paying off the debt first.
This does not mean investing is wrong. It means the order of operations matters. Paying off high-interest debt is often the first step, not because investing is bad, but because the numbers point that way.
Where the Line Falls#
Not all debt is equal. The interest rate determines whether debt is urgent, manageable, or even potentially useful.
High-interest debt (above 10-15%)
Credit cards, personal loans, buy-now-pay-later with late fees. These rates often exceed any reasonable investment return. Prioritising their repayment tends to make sense.
Moderate-interest debt (5-10%)
Car loans, some personal loans. The decision is less clear-cut. The guaranteed return from repayment may be similar to expected investment returns. Other factors, like cashflow stability and psychological comfort, start to matter more.
Low-interest debt (below 5%)
Mortgages, some education loans (depending on jurisdiction). When debt costs less than long-term investment returns, the mathematics of repayment become more nuanced. Some people still prioritise repayment for psychological reasons. Others choose to invest while carrying the debt.
The line is not fixed. It depends on current interest rates, tax treatment, and personal circumstances. But the principle holds: higher interest rates tilt the decision toward repayment.
The Minimum Payment Trap#
Minimum payments on credit cards and some loans are designed to keep you paying for as long as possible. They cover interest and a small amount of principal, ensuring the debt persists.
Consider a $5,000 credit card balance at 22% interest. Making only minimum payments, it can take 15 to 20 years to repay, with total interest exceeding the original balance.² The monthly payment feels manageable, but the long-term cost is substantial.
This is not an argument for guilt or shame. It is an observation about mechanics. Minimum payments extend debt; additional payments shorten it. Understanding this allows for more deliberate choices.
Cashflow Stress and Behavioural Spillover#
Debt affects more than just the balance sheet. It affects how people feel and how they make decisions.
High debt payments consume cashflow, reducing flexibility. There is less room for unexpected expenses, less room for saving, less room to absorb a disruption. This creates stress, and stress affects decision-making across all areas of life, including investing.
Research in behavioural finance suggests that financial stress narrows attention, making people more focused on immediate problems and less able to plan for the future.³ This is sometimes called "tunnelling": the mental bandwidth consumed by financial pressure leaves less room for other considerations.
Reducing high-interest debt is not just about the numbers. It is about freeing up mental space and restoring optionality. People with less debt stress tend to make calmer decisions, both about money and about everything else.
A Framework, Not a Judgement#
Debt often carries moral weight in public conversation. People feel ashamed of it, or they are told they should. This framing is not helpful.
Debt is a tool. Sometimes it is used well. Sometimes it is not. Sometimes circumstances create debt that no amount of prudence could have prevented. The question is not "Why do I have debt?" but "What does this debt cost, and what should I do about it?"
A useful framework:
- List all debts with their balances and interest rates
- Rank by interest rate, highest first
- Direct extra payments to the highest-rate debt while maintaining minimums on others
- Reassess as balances change
This approach, sometimes called the avalanche method, minimises total interest paid. An alternative, the snowball method, prioritises smallest balances first for psychological momentum. Both work. The best method is the one you will actually follow.
When to Consider Investing Alongside Debt#
There are situations where investing while carrying debt can make sense:
Employer-matched retirement contributions. If an employer matches contributions to superannuation or a retirement account, that match is an immediate return. Capturing it may be worth doing even while debt exists.
Very low-interest debt. If debt costs 3% and long-term investment returns average 7%, the mathematics may favour investing, especially over long time horizons. This is a personal decision with trade-offs.
Building a buffer first. Before aggressively paying down debt, having a small emergency fund (even one to two months of expenses) can prevent new debt if something unexpected happens.
These are not rules. They are considerations. The right balance depends on individual circumstances, and people in complex situations may benefit from speaking with a licensed financial adviser.
Summary#
Interest rate is the key variable in thinking about debt. High-interest debt compounds against you faster than most investments compound for you, which often makes repayment the first priority. Minimum payments extend debt for years; additional payments shorten it. Debt also affects behaviour by consuming cashflow and mental bandwidth, reducing the capacity for calm decision-making. None of this is about judgement. It is about understanding mechanics and making deliberate choices. The framework is simple: rank by interest rate, pay down the most expensive debt first, and reassess as circumstances change.
Sources#
- Bankrate. (2025). Historical stock market returns: Average annual return for the S&P 500. https://www.bankrate.com/investing/average-stock-market-return/ (Accessed January 2026)
- Investopedia. (2025). Credit card interest payments: The true cost of carrying a balance. https://www.investopedia.com/credit-card-interest-payments-11744612 (Accessed January 2026)
- Mullainathan, S., & Shafir, E. (2013). Scarcity: Why having too little means so much. Times Books.