The most famous name in the getting out of debt industry is Dave Ramsey. As a young man Dave himself was in a pile of debt and wound up filing bankruptcy. The pain of that experience lead him on a quest to learn about personal finance and he began a career in advising others how to get out of debt.
I’m a talk radio/podcast junkie. I don’t care what the topic is as long as it is interesting. Dave Ramsey is the host of a nationwide talk show and it played on the radio as I was driving home. So, as I counseled clients every day about how to file bankruptcy, I would listen to Dave on the way home explaining how to avoid it. Gosh, was I doing my clients wrong by not teaching them the tough road out of debt that Dave advocated?
The hallmark of the Dave Ramsey system is a series of seven “Baby Steps” one takes to eliminate debt and build wealth.
- Step 1: Save $1,000 Emergency Fund.
- Step 2: Debt Snowball. Pay off all debt.
- Step 3: Save 3 to 6 months of expenses.
- Step 4: Invest 15% of income in retirement.
- Step 5: Establish College Fund for children.
- Step 6: Pay off house.
- Step 7: Build Wealth and Give.
The Debt Snowball is the program to eliminate debt. The basics of the program are as follows:
- List all debts from Smallest to Largest.
- Maintain minimum payments on all debts and get all debts out of default status.
- Devote all extra income to pay off the smallest debt first, regardless of whether that debt has a higher or lower interest rate.
- Reduce expenses, sell off unnecessary possessions, and take on part-time jobs to fund the debt snowball.
- Once the smallest debt is paid, move onto the next smallest debt and then the next smallest, etc., etc., until all debt (except the home mortgage) is paid in full.
Why pay off the smallest debt first instead of the debts with the highest interest rate? Because, according to Ramsey, getting out of debt is 80% emotion and 20% head knowledge.
If it were about math, you wouldn’t have credit card debt. It’s not about math. It’s about behavior modification.
Paying off the smallest debt “fires you up!” says Ramsey, and that small success helps ignite an emotional reaction to kill off the remaining debts. There is actually a lot of scientific fact to back up that claim, especially in the study of healthy habit formation. Small victories do lead to bigger wins.
The challenge is you. You are the problem with your money.
Ramsey focuses on “behavior modification” as the key to solving a debt problem.
Most financial people make the mistake of trying to show you the numbers, thinking that you just don’t get the math. I am sure that the problem with my money is he guy in my mirror.
A large part of the behavior modification is about daring to be radical–to sell your home and fancy car and to take on a part-time pizza delivery job–to drop out of society’s pressure to keep up with the Jones’.
Stop buying things you don’t need with money you don’t have to impress people you don’t even like.
It is hard to disagree with any of this. This is sensible and old-fashion advice to getting out of debt. Cut expenses. Increase income. List the debts and have a plan of attack. Paying off debts from smallest to largest is also a valid strategy since getting out of debt does require a person to be “fired up” and focused.
The power of focus is what causes our Baby Steps to work . . . if you attack too many areas at once you don’t finish anything you start for a long time . . . That makes you feel that you aren’t accomplishing anything, which is dangerous.
The key weakness of the Debt Snowball program, however, is the requirement that you must be able to get all debts out of default status and maintain minimum payments on all debts during the plan. Is that feasible? Can you really maintain minimum payments on all debts and get the delinquent debts current while you pound away at the smallest debt? Yes, some folks just need to cut the cable bill and downsize their life to free up the necessary money to make this plan work, but that simply does not work for the vast majority of people I see on a daily basis.
So, if you squander a lot of money on foolish entertainment, cars, eating out, cell phones, etc., the Dave Ramsey program may work just fine for you. Get on a financial diet and start paying off the debt. Yep, that works . . . if you have the income. But what if you don’t? Then what? What if 25% of your paycheck is being garnished and the judgments are stacking up one on top of another and the mortgage payment is behind on a house worth no more than what is owed? How do you downsize that expense?
And what if you can’t get a second job to speed up the debt snowball? What if your health, both physical and mental, is already taxed to the maximum? What if getting a part-time job means abandoning your children and a stressed out spouse for another 20 hours a week? Is that a smart decision? Sure, you might become debt-free, but will you have a family left to come back to?
Dave Ramsey is a positive voice of reason and encouragement in the personal finance industry. I like his attitude and enthusiasm. Overall, I think we all should really pay attention to his message. Stop lying to yourself and stop pretending to be somebody you are not. Downsize your life, become debt free, and then realize the blessing of truly being a free person. That’s a great message and goal.
But the Dave Ramsey program is not for everyone and it is just not feasible for too many. If you are living beyond your means, try it. But if you are already struggling after devoting every dime to stay out of debt and now you are draining your retirement or mortgaging your home to make minimum payments on debts, consider other options.
Image courtesy of Flickr and Bonnie Brown.