As a small business funder, we commonly see business owners pay off debts faster, ahead of their scheduled payment plan, to save on fees and free up cash flow. This is an excellent strategy to save money on interest when taking on debts.
Before you dive in and pay off debts faster, you’ll need to get the facts on what you owe. Which debt has the highest interest? Highest minimum payment? Longest term? Largest amount? Do any have amortizing interest?
Amortizing interest is when the lender ensures they will not lose out on any profits from interest by putting the total calculated interest payments first before allowing the borrower to pay off the principal sum. When your loan has amortizing interest, paying off your debt early does not actually save you any money, however it does free up cash flow.
Ready to be loan, credit and debt free? Pay off debts faster with these tips.
Start with the Highest Interest
If you’re looking to save money along the way, paying off the highest interest can save you more along the way than a loan charging less interest. This is known as the avalanche method: tackle the biggest debt first, as opposed to the snowball method: tackling smaller debts first to stay motivated. Avalanche vs Snowball method is explained in more detail later.
Refinance and Consolidate
Are multiple loans causing you issues? Having a lender buyout all of your loans can help lower your interest rate, extend payment terms and organize your finances. If your business debt was acquired at high rates when your business was in poor health, refinancing during strong performance can lower your rates significantly and save you thousands that can be put towards the principal loan amount.
Before you thank captain obvious, there are ways you can better limit your spending. As a business owner, making layoffs is a less than ideal way to cut spending. Instead, look at ways to go digital over print, unused software subscriptions, repair old equipment instead of splurging on new. Many small budget cuts add up and that has a ripple effect of saving.
Create Additional Revenue
Maybe you can’t think of any budget cuts. How can you utilize what you already have? Can you rent your equipment? Rent space on the weekends? Donate old equipment for a tax cut? Expand your services offered? Get creative, the opportunities are there. If not, create the opportunity!
Debt Avalanche vs Snowball Method
There are two main methods to paying off debt: avalanche and snowball. The debt avalanche method is when a borrower makes the minimum payments on all debt, then uses any remaining money to pay off the debt with the highest interest rate. This high interest rate could also be the largest amount, which can get discouraging when borrowers have several debts to clear. Those who need motivation to keep achieving their goals prefer the snowball method: paying off the smallest debts first before moving on to bigger ones. Meeting milestones and achievements can play a big factor in staying dedicated to debt repayment, however the avalanche method can result in lower interest accumulation over time.
If you have $30,000 debt on a business line of credit at 20% interest and you pay it off with $3,000 a month payments, you can pay off your debt in 11 months, with $3,000 going to interest.
Ask your lender about interest. Is it simple or compounding? Amortizing? Knowing how your interest is affecting your loan might change the best repayment focus. Talk to your loan provider or accountant for a better idea of your debt interest and how to pay off debts faster.