Between entertaining clients, managing staff, seeking funding and placating impatient creditors, running a startup is a series of challenges. But it’s even tougher when you have to keep up with increasing bills every month as your business grows.
The question is, how will you tackle your business’ debt? Two of the most popular debt-reduction strategies are called the debt avalanche and the debt snowball, both of which work well, but which one to choose depends on your particular circumstances.
In a nutshell, if you’re a frugal entrepreneur and believe in saving as much money as possible down to the last penny, the debt avalanche method will likely work best for you.
But if you tend to be motivated by a quick win or a feeling of accomplishment, the debt snowball method is likely a better fit.
To help you further home in on which method is right for your business, we’ve culled the primary features of each one.
Debt avalanche method
Also known as debt stacking, this method aims to minimize the total interest costs you pay. With the debt avalanche, business debts are paid off in order from the highest interest rate to the lowest, regardless of balance.
To apply the debt avalanche method
- Make an inventory: List business debts by interest rate for every loan and credit card. Start with the highest rate and work your way down the line to the lowest.
- Pay the minimums: Make the minimum payment for all the debts you’ve listed. Although the focus is to pay off one balance at a time, it’s important to keep up on your other bills to avoid penalties or a ding to your credit score.
- Pay extra on the debt with the highest interest rate: If you have additional money available each month, use it to pay extra on the loan with the highest interest rate.
- Build momentum: After paying off one loan, cross it off the list. Start using the money you were paying on that loan to the debt with the next-highest interest rate.
Pros of the debt avalanche method |
Cons of the debt avalanche method |
| Lower costs in the long term. | No positive reinforcement. |
| Debt is paid off faster. | Requires discipline, patience as results take time |
| Requires continuing discretionary income. |
Debt snowball method
The debt snowball repayment strategy works like a snowball rolling down a hill of snow. It starts out small but gets bigger and bigger as it picks up momentum.
Debt snowball pays off business debts in ascending order of size. You first tackle the smallest balance and build momentum toward the larger balances, regardless of interest rate.
To apply the debt snowball method
- Get organized: List debts in order from the smallest balance to the largest. Ignore interest rate and balance.
- Pay the minimums: Make the minimum payments for all the debts you’ve listed except the smallest. This protects you from being assessed penalties and protects your credit score.
- Pay extra on your smallest balance: Every month, pay any extra money available toward the smallest balance at the top of your list.
- Build on your success: After closing out the smallest balance, cross it off the list and move on to the next-smallest debt. Use everything you were paying toward the smallest loan to pay off the next one.
Pros of the debt snowball method |
Cons of the debt snowball method |
| Quickly reduces your outstanding balance | May prolong repayment term as it doesn’t account for interest rates. |
| Forces you to be intentional by paying one bill at a time until your business is debt-free. | Debts with higher interest rates require a larger payment. |
| Gives a psychological boost after paying off each debt. | More expensive as paying smallest debts first incurs more interest on the larger ones. |
| Saves you from paying extra fees charged by debt consolidation firms |
Takeaway:
While both are effective strategies to pay off your debt, you might find one easier to stick with and make a bigger impact on your business finances. However, before you make your decision, make sure to figure out how much interest you’d be liable to pay under each method and how long each approach will take to clear off your debts.
