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Using the Debt Snowball Method to Clear Small Business Debt

The Debt Snowball Method

Running a business is difficult – it’s even tougher when you have to keep up with increasing bills every month. Entertaining clients and placating impatient creditors can be brutal, but it’s something you have to deal with.

The big question is how will you deal with small business debt? There are many methods for paying off your small business debt, and most of them work well. But if you would like to reduce your outstanding balance quickly without professional help, the debt snowball method is a great solution for any business (or individual).

What is the Debt Snowball Method?

Have you ever built a snowman? Most people start by packing a tight ball of snow and rolling it over fresh snow. Rather than collecting fresh snow and taking it to the ball, you let the ball do the work. As it increases in size, it picks up momentum and clears the path behind it.

The Debt Snowball Method is quite similar. This debt reduction strategy focuses on paying off your debts in order of smallest to largest. As you clear your debts one-by-one, you pick up momentum, move on to the next smallest balance, and repeat until debt-free.

How the Debt Snowball Method Works

This method is all about paying off your debts one by one, starting with small debts and ending with the largest – irrespective of the interest rate.  

Let’s suppose you have the following debts:

(i) Credit card debt – $5,000

(ii) Bridge loan – $6,600

(iii) Family loans – $7,000

(iv) Trade Credit – $9,000

With the debt snowball method, you would make the minimum payments on all your debts but make an extra payment on your smallest debt (credit card) until it is paid off completely.

If you must pay a minimum of $100 for all of your debts, you would pay an extra $400 (the amount depends on your affordability). This means you’re paying $500 in total on your smallest debt every month. With an outstanding balance of $5,000, your debt will be paid off in 10 monthly payments.

Once your smallest debt is paid off, you can apply that $500 to the minimum payment on the next smallest debt (bridge loan). Since you are already paying $100 on all of your debts, the newly available $500 allows you to pay $600 towards the bridge loan. With an outstanding balance is $6600, it will take almost 11 months to pay off.

You repeat the process, growing your snowball and clearing the smallest debts until they are completely gone. The momentum will help you stay focused until you finally clear your last debt repayment. Just be sure to make the minimum payment on all of your debts along the way in order to avoid the enormous late fees.

Tricks you can use to succeed

  1.     Create an emergency fund before you start paying off your small business debts with the snowball method (the amount depends on your financial situation). It’s a good idea to save an enough to cover your necessary expenses for 6 months. Use this fund to make extra payments on your debts or as reserved working capital for when cash flows are strained.
  2.     Always make at least the minimum payment on all your debts. Otherwise, you’ll incur fresh debt each month. Fresh debt isn’t just a step backward, it’s also an easy way to lose focus and motivation.
  3.     Evaluate your budget carefully and find out exactly how much you can afford to pay towards your debts. It will take several months to become debt-free with this method and you need capital to support business operations.
  4.     Save money whenever you have the opportunity. The more you save, the more you can put towards debt repayment.
  5.     Have patience; it will take time to pay off your debts. Keep in mind that running your business and paying off your debts simultaneously is a challenging task. Don’t panic or rush, it will compromise your success.

 

The advantage of the debt snowball method

One of the largest benefits of the debt snowball method is that you’ll get psychological boost after paying off each debt. Not only will you be removing a recurring expense, you’ll also have more funds available to tackle your remaining debts. While it takes comparatively less time to pay off small debts, you’ll have more funds to allocate to the bigger ones when the time comes.

This keeps you motivated and focused on your goal, whereas tackling debts simultaneously can show minimal progress, ultimately making it easier to lose your attitude.

Another benefit is that you won’t have to pay any extra fees. Debt relief companies typically charge a sizable fee for helping you pay off your debts. Since you’re taking the DIY approach, you can focus strictly on paying off your debts.

Conclusion

All in all, the Debt Snowball method is a great method for relieving debt. But it does have one fundamental flaw: it does not account for the interest rate. This can prolong the debt repayment term or amount since higher interest rates will require a larger payment.