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Not every celebrity offers good financial advice, but Warren Buffett is one who you should listen to. The legendary investor is known for his value-focused investing style and his down-to-earth personal finance tips.
Let's look at what Warren Buffett thinks you should do if you have credit card debt -- and what this advice can teach us about investing.
Warren Buffett's credit card advice: Pay off high-interest debt first
Warren Buffett was quoted by CNBC speaking about a friend who had asked what she should do with some extra cash. The first question he asked was: "Do you have any credit card debt?"
As Buffett described, this person was carrying a credit card balance that charged 18% APR. Warren Buffett encouraged his friend to pay off credit card debt first, before making any other investment moves. "If I owed any money at 18%, the first thing I'd do with any money I had would be to pay it off," Warren Buffett said. "It's going to be way better than any investment idea I've got."
If you have credit card debt that charges 18% APR, that's high-interest debt. That debt is costing you more money than you can make with any high-yield savings account and most stocks.
If you want to pay off credit card debt faster, using a 0% introductory APR balance transfer credit card could be a good choice.Click here for a complete list of our favorite credit cards with balance transfer offers to help you pay off debt.
Using a balance transfer credit card can help you buy time to pay off credit card debt faster, by reducing your interest costs. But make sure you have a plan to pay off the entire debt by the end of the introductory 0% APR period, or you could end up owing higher interest on the full amount of the balance.
Why high-interest debt is a bad investment
As a legendary long-time investor, it's not surprising that Warren Buffett considers credit card debt through the lens of investing. Paying for high-interest debt is like having a bad investment that costs you money. And every year with credit card debt at 18% APR (or higher), your debt is costing more money than any investment could likely gain.
Even Warren Buffett doesn't confidently believe he can earn more than 18% per year with an investment portfolio: "I don't know how to make 18%," Warren Buffett said. For example, the S&P 500 index has delivered an average compound annual growth rate of 10.7% for the past 30 years. But credit card debt costs more than even this high-yield return on investment (ROI) can deliver. Before you buy stocks, you should pay off your credit card debt.
When to pay off "good debt" more slowly
Not all debt is bad. If you have high-interest debt like that held on credit cards, or a high-interest car loan of 10% or more, you should prioritize paying it off before you start investing.
But there are a few types of "good debt" that can be worth paying off more slowly.
Mortgage debt
If you have a mortgage interest rate of 6%-8%, that is generally considered "good debt," because you're using the debt to buy an asset (a home) that is likely to go up in value over time. And over many years, the S&P 500 index or other stock market investments might deliver a higher yield than you're paying on your mortgage interest.
For example, if your mortgage rate is 6.5%, don't feel as if you should hurry to pay down your mortgage faster. If you invest your extra cash in the S&P 500 index, even if it only earns 8% per year, you're coming out ahead.
Auto loans
Borrowing to buy a car can be a form of "good debt," because it gives you reliable transportation to get to work and live your life. Auto loan interest rates are based on the age of your vehicle, the length of the loan term, your personal credit score, and other factors. It's true that some auto loans charge high interest rates, and you might want to pay off that debt faster if possible.
But some of the best auto loans have APRs of 6% or lower. If you have a low-interest auto loan, you don't have to make extra loan payments to pay it off faster. Instead, you might be better off keeping your extra cash in a high-yield savings account that pays 4.00% APY or higher. Even if your cash doesn't earn a higher APY than the APR on your auto loan, preserving your extra cash and keeping your options open can give you peace of mind and be a good financial strategy.
Bottom line
Warren Buffett is legendary for earning high returns in the stock market, but even he knows the value of paying off high-interest debt first. Before you start putting extra cash into stocks, make sure you pay off your credit cards.
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