Credit cards are essential financing tools for all types of small businesses that are not eligible for small business loan in their early stages. In fact, according to NSBA 2017 Year-End Economic Report, 31% of small businesses used credit cards to meet their capital needs.
Because of my profession, I get asked often enough by my clients questions like, “What is the best way to pay off the credit card debts?” or “How should I make my credit card payments to pay the least interests?”
So in this post, I would like to share 2 simple and effective strategies that are recommended by many financial professionals: the avalanche method and the snowball method.
Both methods work by first making the minimum payments for all the cards then putting what you have left to one focus account every month, instead of equally distributing your money to all accounts. After that one focus account gets paid off, you move on to the next focus account.
Here is how they differ from each other:
1. The Avalanche Method (logical method)
After making the minimum payments to all accounts, you put whatever money you have left to the one account with the highest interest rate until the account gets paid off and move on to the next highest interest rate.
The reason avalanche method considered a logical method is because it makes the most sense mathematically. You will pay less in interest following this approach.
2. The Snowball Method (emotional method)
But because we humans are complicated creatures, following logic doesn’t necessarily work for us all the time. Thus the snowball method exists. It works by putting the extra money after making minimum payments into one account that has the lowest balance, until you pay it off and move on to the next smallest balance.
The snowball method was considered emotional because it affects the debtor’s motivation. Paying the smallest balance first makes it quicker to see a debt gets paid off, giving the debtors a clearer sense of progress, which in turn makes them more motivated to stay on track and pay off the debts.
According to a study by Harvard Business Review, the snowball method is the more psychologically effective method and should be used.
No matter which method you choose to pursue, the important thing to remember is to have a clear budget, put any extra money you find every month into the one focus account until it gets paid off.
Want more financial tips for small businesses? Check out my previous post here.
