See also: Dave Ramsey is Good at Psychology
If you’re familiar with Dave Ramsey, then you’ve no doubt heard of his ’snowball’ approach to paying down your debt. In short, Ramsey suggests that you make minimum payments on all but the debt with the lowest balance. Once the low-balance debt is paid off, you add the dollars that had been going there to what you’ve been paying against the next lowest debt. And so on. The idea is to pick up steam in paying down your debts by knocking them out one by one, and piling up the payments that would have gone to each of the paid off debts in order to knock out the next one. Sounds enticing, but is it a good idea?
To my mind, what you should really be doing is paying down the debts with the highest interest rate, regardless of balance. It just makes intuitive sense to pay off the most costly debts first. Once the debt with the highest interest rate is paid off, add those dollars to what you’ve been paying on the debt with the next highest interest rate, and so on. So who’s right?
I was actually inspired to look into this in greater detail by a recent post over at the Wealthy Blogger (Update: That site, and thus the post, have gone missing). In that post, Mike introduces yet another approach. As outlined in The Automatic Millionaire, this approach is based on the ratio of the outstanding balance to the minimum amount due. Divide the latter into the former, and concentrate your payments on the debt with the lowest resulting value. Once that’s paid, add the dollars that had been going there to what you’ve been paying on the debt with the next lowest ratio. Lather, rinse, repeat. Again, sounds like it might be a good idea. So let’s look deeper.
Consider a family with the following debts:
Visa ($7,500 @ 13%, minimum payment = $150/month)
MasterCard ($10,000 @ 19%, minimum payment = $250/month)
Car Loan ($5,000 @ 8%, minimum payment = $275/month)
Note that I essentially picked these values out of thin air.
Now, let’s first consider what happens when you make only the minimum payments month after month:
Visa:
Months to pay in full: 72
Total amount paid: $10,685.54
Total interest paid: $3,185.54
MasterCard:
Months to pay in full: 63
Total amount paid: $15,544.23
Total interest paid: $5,544.23
Car Loan:
Months to pay in full: 20
Total amount paid: $5,310.14
Total interest paid: $310.14
So it would take a grand total of 72 months and $31,539.91 to pay off the initial $22,500 in debt. Not too good.
Now let’s assume our hypothetical couple can actually afford to pay $1,000 per month toward their debts, rather than just making the minimum payments. What’s the best way to allocate these dollars? According to Ramsey, they should attack the car loan first, since it has the lowest balance. In other words, they’ll be paying $150/month toward their Visa bill, $250/month toward their MasterCard, and the balance ($600/month) toward the car loan. Using this approach, the car loan gets paid as follows:
Car Loan:
Months to pay in full: 9
Total amount paid: $5,126.70
Total interest paid: $126.70
At that point, the next highest balance is the Visa, so they add the $600/month from the car loan to the $150/month they already been paying, and they finish off the Visa.
Visa:
Months to pay in full: 19
Total amount paid: $8,477.38
Total interest paid: $977.38
And from this point on, the entire $1,000 gets poured into the MasterCard until it’s gone.
MasterCard:
Months to pay in full: 27
Total amount paid: $13,013.74
Total interest paid: $3,013.74
So it’s all done in 27 months at a cost of $26,617.82. That’s a net savings of 45 months and $4,922.09 in interest payments. Not too shabby. But could they do better?
Let’s look at what would happen if they hit the highest interest rate first. In this case, they’d attack the MasterCard, Visa, and car loan, in that order. The result? The MasterCard ends up as follows:
MasterCard:
Months to pay in full: 20
Total amount paid: $11,572.27
Total interest paid: $1,572.27
Coincidentally, due to the lower initial balance, the car loan ends up getting paid off during that same month, even thought they’ve only been paying the minimum amount each month.
Car Loan:
Months to pay in full: 20
Total amount paid: $5,310.14
Total interest paid: $310.14
So now the whole ball of wax gets applied to the Visa, wiping it out as follows.
Visa:
Months to pay in full: 26
Total amount paid: $9,093.73
Total interest paid: $1,593.73
So they’re out of debt in 26 months at a total cost of $25,976.14. That’s a month sooner, and they’ve saved an additional $641.68.
What about the approach advocated in The Automatic Millionaire? In this case, the car loan has the lowest initial ratio (and it turns out that it remains lower until it’s paid in full). Thus, as with Ramsey’s approach, our hypothetical couple starts out hitting the car loan the hardest, at $600/month.
Car Loan:
Months to pay in full: 9
Total amount paid: $5,126.70
Total interest paid: $126.70
At that point, the MasterCard has the lowest ratio (and it remains lower than the Visa until it’s paid off). So they switch to paying $850/month on their MasterCard and continue paying the minimum on their Visa.
MasterCard:
Months to pay in full: 21
Total amount paid: $12,052.55
Total interest paid: $2,052.55
And now it’s time to kill off the Visa.
Visa:
Months to pay in full: 27
Total amount paid: $9,114.65
Total interest paid: $1,614.65
Thus, in this case, the more convoluted, ratio-based approach takes the same length of time as Ramsey’s approach, although the remaining payments in that final month are slightly lower, bringing the total to $26,293.90. This is a savings over Ramsey’s approach of $323.92, owing to the fact that the vagaries of the numbers that I picked to start with resulted in the high-interest MasterCard getting attacked before the Visa.
The bottom line…
Snowball: 27 months; $26,617.82
High interest first: 26 months; $25,976.14
Automatic: 27 months; $26,293.90
If you work through the math, the best you can hope to do (in this specific case, as well as in any other) is to attack the highest interest rates first. In some cases, Ramsey’s approach will equal this approach (if lowest balances are on highest rate debts then the two approaches are the same), but it will never exceed it. Similarly, the approach advocated in The Automatic Millionaire will, in some cases, equal the performance of the high-rate approach – but only if the ratios work out such that the highest rate debts get paid first. But, like the ‘debt snowball,’ this approach will never beat the high-rate strategy.
With regard to Ramsey’s approach vs. the Automatic approach, the relative performance for any given scenario will depend on the numbers. In some cases, Ramsey’s approach will do better, in others it won’t.
I should note here that, although the numerical differences in this particular example aren’t that huge, they can work out to be pretty sizable depending on the amount of debt involved and the structuring of the interest rates.
This isn’t to say that an approach such as Ramsey’s isn’t worthwhile. For example, under Ramsey’s scheme, the first debt gets knocked out very quickly, and some people may need that psychological boost to keep at it. In contrast, it took twenty months to knock out the first debt under the high-rate scenario, although two debts (MasterCard and car loan) ended up getting knocked out that same month.
But for people with sufficient self-control, you can do better by paying off debts from highest to lowest interest rate. Then again, maybe people with self control don’t get into debt in the first place…
Great analysis. Interesting to see 3 approaches compared.
I will say that the Dave Ramsey approach has one key point that does greatly differentiate it from any other method…
Ramsey advocates “small victories” to get someone started. To someone that has a great amount of debt, the thought of being debt-free can seem about as doable as winning the lottery. I can see how knocking out your smallest debts can give you that extra boost you need to continue the path to becoming debt-free. To only be receiving 7 bills in the mail every month instead of 10 keeps your mind on the optimistic side of the field.
However, if you are the type that is mathematically oriented and you are 100% committed to becoming debt-free, then Dave’s approach could become irrevelant, as you don’t need the small victories.
As for me, I have been dieting now for 6 weeks and I have lost 1-2 lbs per week. I wonder how I would have felt if nothing had happened in weeks 1 thru 5 and then one night a huge chunk of my butt just fell off! I bet thats what it’s like to knock out that killer $20,000 credit card debt!
Comment by Michael — May 9th 2005 @ 10:36 pm
Comment by nickel — May 9th 2005 @ 11:09 pm
Fortunately for us, Quicken has a free online debt reduction planner that considers balances and interest rates and develops the same strategy. It’s how I decided which credit card to pay off first, and I’ll have to say, I’m happy I did with two successes under my belt! The only down side is that it doesn’t take into consideration planned rate changes (like a card that will go from 0% to 9% or whatever).
Comment by Joshua Kersey — May 10th 2005 @ 12:14 am
A better overall approach would be to first call up customer service at your credit card with the lowest interst rate, in this case Visa, and simply ask them to lower it. Most times they will knock a few percent off with very little coaxing. Then call the customer service at your other credit card company and try to negotiate a better rate using your lower rate as leverage. If one rate is still significantly lower, as in the example above (13% compared to 19%), raise the limit on the card with the lower rate and transfer a portion of the balance from the other card leaving enough open credit to not hurt your credit score. Then start paying the minimum on the car loan and the lower rate card and pay the rest to the higher rate card. This will approach should have the balance paid off sooner with the least interest paid.
Comment by Brian — May 10th 2005 @ 5:26 pm
While I was working on my MBA, I came across Dave Ramsey on the radio. Initially I listened because he is very entertaining to listen to. Secondarily, I was intrigued with the “debt snowball”. I could not believe what he was saying (especially since I was in the middle of my final finance class). As a 30-year old who had been paying down credit card, school loan, and car debt for 10+ years, I was practically an expert to boot!
There is no doubt that, mathematically, paying down the highest interest rate debts saves money - on paper. The problem is human nature. You can’t close an account with a balance (at least most of the time). By paying a debt to zero you have essentially “killed” that debt. Since my ten years of “expertise” didn’t seem to work, I gave the snowball 18 months to see what it could do. That 18 months turned into 3 years and allowed me to get rid of $65,000 in consumer debt. Even being an analytical person, the emotional factor was the missing ingredient I needed.
For some, maybe going highest interest works, for me I just needed an emotional boost. We now only have the debt of our home and it feels oh so good.
It’s good to see that there are people that are essentially on the same team trying to get rid of debt. Dave Ramsey condones such things - keep it up.
Comment by Jeff K. — May 17th 2005 @ 8:39 pm
Human psycology is interesting, and has to be factored into debt reduction plans.
Some people feel that they have made progress if they can close open credit card accounts.
Other people feel progress if they can reduce outstanding balance.
I can only feel progress if my networth number climbs month by month at a faster pace that it climbed the last month.
Whichever works for you, but keep owning more, and owing less
My contrarian method for Credit Card Management.
Comment by Jose Anes — Jun 7th 2005 @ 12:21 pm
In his defense, I’ll say that Dave makes no qualms about why he advises debt payoff in the manner he does:
“We are more concerned with modifying behavior than correct mathematics,” he writes. “Being a certified nerd, I always used to start with making the math work. I have learned that the math does need to work, but sometimes motivation is more important than math. This is one of those times.”
I didn’t work my debt payoff Dave’s way, but I understand entirely the motives behind it. The people who most need Dave’s advice are probably those who are also most likely to need the psychological “umph” provided by lopping off their debts one by one, and having some quick successes.
Those of us who understand the intricacies of all this … well, we have spreadsheets to tell us what to do, rather than a Type-A personality on the radio.
It’s not likely that we would give up so easily, either.
Comment by Michael — Jun 12th 2005 @ 5:57 pm
That umph means a lot. I know in my case killing off some low-hanging fruit really boosted morale with my wife and I.
Comment by Mike Hillyer — Jun 16th 2005 @ 12:47 am
You have a miscalculation in one of your scenarios.
In the one that contains
If you paid 20 months on the car note you’d have paid it off at least twice.
Otherwise this is a great piece. I have a buy-side stock trading MBA friend who taught me this valuable lesson about 6 years and $50,000 in student loans ago. I used to attack the smallest balances first, enjoying the small victories of getting Paid-In-Full notes back from the banks, but he finally convinced me that it is always numerically better to pay off the highest interest rate first.
Comment by The Comedian — Jun 29th 2005 @ 4:28 pm
Comment by nickel — Jul 5th 2005 @ 10:11 pm
Ramsey’s approach certainly doesn’t make the best financial sense. But as a CFP who has worked with individual clients for over 10 years, I know that lack of self-dicipline is the greatest factor in financial failure. The “small victory” plan Ramsey proposes can help many.
Comment by thc — Jul 19th 2005 @ 2:07 pm
I think Dave Ramsey’s advice works well for his target audience, like the commenter above suggests. For instance, he also says to not have any credit cards at all. For people who can’t handle a credit card, this is good advice.
Comment by Jonathan — Aug 13th 2005 @ 9:38 pm
We used Ramsey as a jumping-off place. Working from a place of emotional isolation, as many debt-heads do, it is helpful to hear a friendly voice telling you that you can conquer the beast, and then giving you a practical plan to get started.
In many ways, ANY plan is better than NO plan.
Comment by The Aardvark — Sep 26th 2005 @ 8:01 pm
If you’re really following Dave’s plan and are intense about the interest won’t hardly amount to much anyway. And if people were good at math they wouldn’t be in debt in the first place.
Comment by DigitalMan — Oct 7th 2005 @ 8:20 am
No, Ramsey isn’t bad at math, since he has often said that, strictly mathematically, paying highest interest first makes more sense. But comparing the two methods assumes you complete both methods - which is not the case even close to 100% of the time for either. Based on Ramsey’s 20 some years of counseling folks in debt, he’s found that in using his method they actually complete the process much more often, thus on average getting out of debt faster than those who use the higher interest first method. Which means using Ramsey’s method makes good mathematical sense.
Just curious, how many years of successfully counseling folks on getting out of debt do you have under your belt? Yeah, that’s what I figured.
RLR
Comment by RLR — Oct 7th 2005 @ 9:15 am
I completely understand and recognize the wisdom of Ramsey’s thinking. In fact, if you read closely, you’ll even see the following:
“This isn’t to say that an approach such as Ramsey’s isn’t worthwhile. For example, under Ramsey’s scheme, the first debt gets knocked out very quickly, and some people may need that psychological boost to keep at it. In contrast, it took twenty months to knock out the first debt under the high-rate scenario, although two debts (MasterCard and car loan) ended up getting knocked out that same month.”
The whole “Bad at Math” title is somewhat tongue in cheek. And you’re right — I haven’t spent much time counseling people on how to get out of debt. But I *have* spent the last 35 years staying out of debt.
Comment by nickel — Oct 7th 2005 @ 9:35 am
As others have pointed out in defence of Ramsey, he does not claim the snowball method is the best mathematically — only that in the real world IT WORKS. It works because people are no computers. People need positive reinforcement and the emotional boost given by getting bills paid off and starting with the smallest ones does just that. I can tell you from experience that I have tried and failed with other methods of getting out of debt but I am sticking to the debt snowball.
Comment by petehatesdebt — Oct 7th 2005 @ 10:40 am
“If we were doing math, we wouldn’t be in debt in the first place.”
– Dave Ramsey
Comment by mr_peanut — Oct 7th 2005 @ 5:15 pm
I don’t know if I can really add anything else to what has already been said by Dave’s proponents. It’s a plan that changes behavior, and poor behavior with money what gets most people into trouble. If someone has the self discipline to do it by interest first and keep with it, that’s great. But smallest first has helped motivate me. All my annoying small debts are out of my way and I can concentrate on the big stuff now.
Dave frequently gives advice that is not mathematically optimum, and he admits this is so, but the objective is to change your behavior and attitudes.
Comment by Yo Spiff — Oct 7th 2005 @ 6:43 pm
Actually, there is one more thing to consider. Which helps you pay off best at the lowest cost AND helps improve your credit score in the process.
I don’t have time to do the analysis but if your objective was to increase your credit score (FICO) to purchase a home next year then your payback plan would likely benefit from a change.
For example, you get a big ding on your credit report for having large revolving credit and/or being close to the maximum. Let’s say that the credit limit on the Visa was 7.5k and it’s maxed out. This gives your a 100% ratio and perhaps knocks 50 points off your score. Are you better off paying at least half of it off first to increase your credit score by 25 - 40 points?
By improving your credit score, your interest rates on all other debts comes down (in theory).
So if this were the case which would you pay first to optimize your credit score AND reduce your debt?
Visa ($7,500 @ 13% AND 100% maxed, minimum payment = $150/month)
MasterCard ($10,000 @ 19% AND 50% maxed, minimum payment = $250/month)
Car Loan ($5,000 @ 8%, minimum payment = $275/month
Note that the car loan has the least negative effect on your credit score (provided you are not late) so perhaps this should be paid last?
-Guest
Comment by Guest — Oct 13th 2005 @ 4:47 pm
$7500 balance on $7,500 limit = 100% usage
$0 balance on a $30,000 limit = 0% usage
If we average the usages, you’d be at 50%. If you sum the balances and the limits and then figure usage, you’d come up with $7,500/$37,500 = 20%.
Comment by nickel — Oct 13th 2005 @ 7:52 pm
According to various websites, the FICO credit/debt ratio is done per credit card vs. aggregate combination.
Here is an excerpt from http://homebuying.about.com/cs....._score.htm
Keep Debt to a Minimum
* Keep your credit card balances low. High debt-to-credit-limit ratios drive your scores down.
* Pay off debt, don’t move it around. Owing the same amounts, but having fewer open accounts, can lower your score if you max out the accounts involved.
* Don’t close unused accounts, because zero balance might help your score.
* Don’t open new accounts that you don’t need as a quickie approach to altering your debt-to-credit-limit ratios. That can lower your score.
Comment by Guest — Oct 14th 2005 @ 9:56 am
As dave would say it,
Don’t worship at the alter of FICO score!
Comment by ramsey Fan — Oct 14th 2005 @ 1:00 pm
I am the one who coined the phase “payment snowballing”. Back in 1994 I created a free program call “Credit Card Math” available from http://www.creditcardmath.com.
I was in the US Marine Corps at the time. Since then many, many people have taken my idea and run with it.
Thanks for letting me toot my horn.
Comment by Michael Riley — Oct 25th 2005 @ 7:47 pm
Um, Michael, I’m not saying Dave Ramsey coined it, but it was in his book “Financial Peace” in 1992…so…
When exactly did you “coin” the phrase? Some time before then?
Comment by JWM — Nov 2nd 2005 @ 6:20 pm
The mathematical in your example because you had only thre debts, each sizeable. I started out about three years ago when I went “on the wagon” and made a vow against new debt and to pay of all my debts. I had 22 debts, ranging from the $30 that I had owed the babysitter for a month, $68 to the plumber, $280 on my kid’s trumpet, things like that, on up to almost $20,000 to Mastercard.
Of my 22 debts, 17 were under a thousand dollars. Using Ramsey’s snowball system, I paid off all of those smaller debts in the first year. (Actually 14 months.) A lot of positive reinforcement, and much less finagling, juggling and keeping track with only five debts instead of 22. A lot of local small businesses were happy to see me walk in the door, money in hand. Under your model, the babysitter and plumber would still be waiting.
I don’t think that having only 3 debts to juggle is realistic model to usein the real world. It does make the math easier, though.
Onree
Comment by Onree — Nov 8th 2005 @ 6:34 pm
Many of you have some good points, however, as Dave says “if we were doing math, we would not be in credit card debt.” Mathmatically, credit cards are not a good deal. Here is why banks have the tallest buildings in every major city. The bank borrows your money at 2%-4% (if your lucky) in the form of a savings account in the meantime they let us borrow their money at 10%-20% in the form of a credit card. You multiply this by however many millions of people and they make a very healthy spread and are able to afford the tallest buildings and nicest furniture off of the general public’s lack of understanding of how money really works. Banks and credit card companies are a lot of things but “dumb” isn’t in the equation. It is just like Las Vegas. I hear people all of the time say they win over time gambling on boats and betting football games. Ok, they are right, they as an individual are beating up on Vegas and the credit card companies. They have multi-million dollar businesses out-smarted. Give me a break. Las Vegas does not have those big hotels because they lose and bookies dont drive around in expensive Cadillacs because they lose either. Mathmatically, I guess a financial professor could calculate how paying the highest interest rate would save you money, but how many rich financial professors do you know. It is emotion that got you into the mess, and it is emotion, not math, that will get you out. I am not saying to totally ignore math, but you have to get quick wins to stay motivated. I guess when one of the bloggers has as much success in people out of debt with their method as opposed to his, then we can talk. As one of the bloggers said, the important thing is that many people on this site are trying to get out regardless of the method. I can tell you from experience though, Ramsey’s method works and my life has never been better financially because of his common sense approach to personal finance. Good luck to all and get gazelle intense!!
Comment by #1 Ramsey Fan — Jan 20th 2006 @ 8:37 pm
Comment by nickel — Jan 22nd 2006 @ 2:51 pm
Nickel says,”How many poor or debt ridden finance professors do I know?” The answer is a lot along with many CPA’s, Tax Advisors, Attorneys, Bankers, and even some Doctors. I guess it depends on your definition of poor. Many average income debt free people have more disposable income than a Doctor for example because most Doctors get out of school with huge student loans and they immediately live the “Doctor Lifestyle” (leasing a Mercedes/Lexus, buying an expensive home, boat, etc) all in an attempt to prove to people that they have “made it” when in fact all of the great income they are producing is funding the bank and going out in payments. The problem with finance professors and academia when it comes to finance is their justification for everything is leverage (using other people’s money). The only problem is they always talk in terms of a “best case scenario” and forget sometimes to consider risk. In a “best case scenario” the math would work everytime, however that is not how life works. As the bumper sticker says —-happens. I dont think Donald Trump is wondering where his next meal is coming from, but he found out a little bit about how “leverage” can bite you when he declared bankruptcy because he had too much money tied up in leveraged real estate. This, by the way, is also what happened to Dave Ramsey, however he has learned his lesson and passed it on. If you always depend on the “best case scenario” a basketball coach would never have to make adjustments at halftime according to what the other team does. Don’t get me wrong there are plenty of people who have made a fortune “leveraging” everything in sight. These people though are few and far between. You can win a lot of money in Las Vegas as well, but you will have to risk a lot to do it and not many people can win in the long run playing this game. It reminds me of these 3:00 am info-commercials saying that you can acquire real estate with no money and leverage your way to the bank in just 30 days. Some of this is fine, but for most people it is false hope and pipe dreams. If people have been successful with this type of thinking then thats great,more power to them. Being able to take risks and come out ahead is part of what makes our country great. As for me, I would rather take it a little slower and pay CASH for everything thereby lowering my risk and maybe my return, but so what if it takes a little longer, most people I know that have money have built wealth over time not with a $3.00 lottery ticket. The next time you are in a “rich neighborhood” look around and see how many “for sale” signs you see. Some of these people are so leveraged and have the desire to impress others so much that they cannot buy furniture for their castle or if they do they put it on another brilliant idea a home equity loan. Lets build up equity in our largest asset and then borrow on it so we can owe more almost then it is worth. Why do you think the banks push this stuff so hard. Why do you think every car commercial you see is trying to get you to LEASE or “FLEECE” as Dave would say. The reason is because we are losing and they are winning! We have to step out of our microwave “I want it now” attitude and think about the incentives companies have when they try to sell us these type of products. Put yourself in their shoes and ask the question “why” It is simple why companies spend millions of dollars on adverting because it works! As Dave says: “If you want to be rich, look aroung and see what rich people are doing.” You will find that people that truly have money behave in a way that is much different than we see on TV or in the movies. Georgia State Professor and author Thomas Stanley proved this in his book “The Millionaire Next Door.”
Comment by #1 Ramsey Fan — Jan 27th 2006 @ 8:31 pm
Jeff K, yo spiff, petehatesdebt, and RLR have the right idea! Modify BEHAVIOR and you will get out. Believe me, I am living proof that it works!!
Comment by #1 Ramsey Fan — Jan 27th 2006 @ 8:45 pm
comments anyone? How many of you agree/disagree?
Comment by #1 Ramsey Fan — Feb 7th 2006 @ 8:14 pm
Since buying my Sirius I’ve been listening to Dave Ramsey. As a financial counselor and CFP candidate myself, Dave is preaching some bad stuff, especially when it comes down to paying off your debt by paying off the “lowest balance” first. WRONG, WRONG, WRONG. Any financial person knows, as has been said here, that you conquer the highest interest rates first in order to pay less interest over time.
Secondly, Dave told one called to simply “work your PMI into your mortgage”!!! What?! Now you’re paying PMI for life. C’mon Dave, be responsible and if you think folks should “pay off” their mortgages first before anything else (retirement savings, etc.), then you’ll have a bunch of retirees with nothing to show but an illiquid asset and no cash for spending.
Gregg
Comment by Gregg Hudak — Feb 9th 2006 @ 8:37 pm
In response to Greg’s analaysis of Dave Ramsey–It doesn’t sound like you have been listening to Dave on Sirius for very long, or if you have you have not been listening closely enough. I have been listening to Dave for about 3 years, and not once have I ever heard him say to pay of your mortgage before you start saving for retirement. If you listen to him, he talks about the “Baby Steps.” If you say you listen to him, you know what I am talking about because he says it everyday.
1) baby emergency fund of 1000.00
2) pay off all debts -debt snowball
3) finish the emergency fund 3-6 months expenses in the bank-Murphy Repellent
4) 15% of income into 401k and ROTH IRA
5) College funding (if it applies
6) Pay off mortgage early
7) Build wealth like crazy-Give a lot away
The last time I checked “4″ comes before “6″ so he does not suggest paying your mortgage off before you do retirement. What he does recomend is that when you pay off all of your debt and have no payments, it is easy to attack you largest debt (your mortgage) and fund your retirement vehicles 401k roths etc at the same time. IF it came down to paying off your mortgage and funding retirement but you could not do both. He would tell you to fund retirement first, and then pay off your house. His point is that if you are not funding the bank with payments it is easy to do both. Dave talks all the time about being “house poor” meaning you dont necessarily want to have a paid for house and no money. Almost everyday!!
As far as the intrest rate/lowest balance first argument, I will garauntee you that if we take 100 people and had 50 of them do it your way Highest interest to lowest–(regardless of the balance) and 50 people Dave’s way lowest balance to highest balance(the debt snowball) I will garauntee that his way will win more often than yours. This is changing behavior, not math. I cant stress that enough. When you are dealing with something emotional whether it is losing weight or losing debt, you need some quick wins!! IF you pay off the debt as quickly as Dave suggest the math wont make any difference anyway. If you want to stay in debt longer, and save enough interest to buy a Big Mac when your done go ahead, but I along with thousands of others have done it Dave’s way and IT WORKS–PERIOD. At the bottom I was making HUGE payments and I never would have done that paying off the highest intrest rate first. When you get as many people out of debt in your financial couseling business as Dave Ramsey has then maybe we will have an arguement
Comment by #1 Ramsey Fan — Feb 10th 2006 @ 6:53 pm
It’s obvious those that only listen to what Dave teaches have an abundance of opinions. Good for you. But Dave has an abundance of practical solutions for practical people who don’t care about math…they care about freeing themselves from debt. Dave also has an abundance of listeners and people who have done it his way and have gotten out of debt.
People can talk all they want about how the math doesn’t work, but, when it comes down to it, people will make changes and progress when they decide to change. And motivation, which is what Dave’s plan includes, is a huge part of it.
Comment by Emma — Feb 20th 2006 @ 1:37 pm
Unfortunately, many people don’t have the willpower to pay off the debt with the highest balance first.
Logically, it makes sense to pay off the balance on the highest interest rate first, but some people will feel that they’re not making enough progress with that method.
If you can pay off your smallest debt and erase it completely, it will help give you the confidence and momentum you need to continue.
You just have to decide which method is best for you. You’ll end up spending more with Dave’s Snowball method, but you’ll see the number of debts you owe shrink.
Comment by Ben — Feb 23rd 2006 @ 3:37 pm
If the difference in savings was thousands instead of hundreds then I could see why the “highest interest” method would be the best bet every time. But since that’s not the case, I think people need to do what works best for them. For my wife and I, grabbing the low-haging fruit was essential. Seeing 1, then 2, then 3 … less bills per month in the mailbox was an unreal motivational tool. In 6 mos., we managed to pay off $10,000+ in credit cards, student loans and car payments - and are now, excepting our mortgage, debt free! We are also very close to having our 6 months of expenses in the bank. That’s a $25,000 turnaround in one year. In the end, use the method that works. In our case, the was the snowball.
Comment by Brivers — Mar 13th 2006 @ 11:27 am
Hah, I just looked your numbers and you completely missed the debt snowball theory. You have made assumptions that minimum payments will be made on ALL debts, which is inaccurate. Then, you make the case that should you have $1,000 to pay off debts, you’d still pay more in interest than paying off high interest debt. Wrong, wrong, wrong.
This is the debt snowball. List your debts from smallest to largest. After devising a budget, a plan, accounting for necessities only, no vacations, no luxuries, you can see how much money you have available to repay debt. It’s amazing how much you have, really.
Once that is determined, you pay minimum payments on all your debts, with the exception of the little one. That’s right. You attack the little one with more than the minimum payment.
So, with your numbers you provided, the smallest one would be the car at $5,000 with a minimum payment of $275.00. Let’s say that you have $1,000 a month to pay off debt, and you should since you have a total of $675 in minimum payments, you would pay $150 on Visa, $250 on Mastercard and a whopping $600 on the car! In 9 months, that car payment will be gone.
Now, here’s the trick. Take that $600 you were paying on that car, and roll it over to the next debt, which, in this case, is the Visa card with a $150 payment. Now, you are paying $750 per month! In those 9 months you managed to pay down the Visa card to $6150.00. With a $750 per month payment, that card will be paid off in another 9 months.
Your remaining debt will be Mastercard, now with a balance of $5,500, reduced from $10,000 with those $250.00 payments over 18 months. Rollover the $750 to this minimum payment of $250 and you are now paying $1,000 per month! In 5 and a half months that payment will be eliminated and in approximately 23 months, you will be debt free.
That is how the debt snowball works!
Comment by Emma — Mar 14th 2006 @ 9:42 am
I understand exactly how the snowball works, and my example is perfectly in line with it. You have to, at a bare minimum, make the minimum payment on all debts, otherwise you will go into default. If you can make afford to make additional payments on the smallest one, then you can (and should) do so. But this only accelarates the process, it doesn’t change the rank performance of the debt snowball vs. the other methods. No matter how much or how little extra you apply to the debt that you choose to knock out first, the debt snowball can never do better than to match the highest interest first method.
In your example, you upped the amount available for debt repayment, and applied the extra money to the smallest balance. To make a fair comparison, however, you have to make the same amount available for the other scenarios. And if you did so, you would see that, at the very worst, the highest interest first scenario would match the performance of the debt snowball, and in most cases, it would outperform the snowball. Because the time to total repayment would be accelarated across the board, the magnitude of the difference would shrink but, as I noted above, the rank order will remain the same.
I should also reiterate a point that I made in the original post that seems to have been lost on many commenters:
“This isn’t to say that an approach such as Ramsey’s isn’t worthwhile. For example, under Ramsey’s scheme, the first debt gets knocked out very quickly, and some people may need that psychological boost to keep at it. In contrast, it took twenty months to knock out the first debt under the high-rate scenario, although two debts (MasterCard and car loan) ended up getting knocked out that same month.”
Comment by nickel — Mar 14th 2006 @ 10:00 am
nickel, yes, I did up the amount. Why? Because, most people in debt have that extra cash somewhere. Either in pizza money, cable/satellite money, cell phone money, or whatever expenditure that is not a necessity. This is the most crucial element of the Ramsey plan, if you have debt, your focus should be on eliminating it. That means no vacations or luxuries until it’s gone.
I do remember that point in your original post. Although, I have to say that personal finance is not about the numbers, it’s behavior. Face it, debt wouldn’t be an issue if we were doing math to begin with.
Comment by Emma — Mar 14th 2006 @ 11:16 am
Comment by nickel — Mar 14th 2006 @ 1:20 pm
Thanks nickel, that was my main argument. By the way, I enjoy your blog. I don’t agree with everything or everyone that posts, but I do have an open mind and appreciate other views on personal finance. Keep up the good work!
Comment by Emma — Mar 14th 2006 @ 1:49 pm
My wife and I are on Dave’s plan.
The only thing in your example that I disagree with is that a person would have an extra $325 to put toward that first bill. We were lucky to scrape together an extra $40 to put toward our smallest debt. Today, 13 months into the program, we put about $1300 toward the next bill on our list. By the end of the year, we will have paid off a total of 34K in 21 months.
It is psychological. If I have to pay a little extra for that, so be it.
I found your site because I was trying to find something negative about Dave and his program. If this is it, then I am very happy.
Thanks for your input nickle.
John
Comment by John — Apr 1st 2006 @ 1:23 am
We had tried the mathematical approach, using info from an About.com financial guy. I guess we just lost focus, and we had at that time, probably 85k in debt (all non-mortgage). By the time we found Dave Ramsey, we had about $125,000 in student loans, car notes, credit cards & 401k loans. 2.5 years later, we have just $16,000 to go, and that will be gone in a few short months. This stuff worked for us, as we found out, it’s not about math when you get that much in debt. NOW, as we begin to invest, save for our future, pay for college, et all, it WILL be about the math. The mathematical scenarios are so much more fun to look at when you are discussing returns, versus paid interest, that’s for sure!
Comment by STEVEN FARRAR — Apr 4th 2006 @ 9:16 pm
You are using your head way too much. Personal finance is 80% behavior and 20% head knowledge. Yes, it would save a little bit of money to pay off the high interest rates first, but it’s about a whole lot more than that. If you go on a diet and the first week you lose a few pounds, you think, great I can do this, this works. It’s the same thing, you eliminate a payment and you start to see that you can do this stuff. Dave Ramsey will even tell you he said the same thing you are saying, but then he realized it made it easier for people when they saw some progress.
Comment by Darin — Apr 14th 2006 @ 8:43 am
Just to add one other thing. If we are all math wizards, then why are we in debt. If you can add and you know you have $500 to spend but you use a credit card and spend $800 then you are not very good at math. Once it again, it’s not about the math.
Comment by Darin — Apr 14th 2006 @ 8:50 am
Okay, well everyone has pretty much expressed all of the different ideas surrounding this debate, so anything that I say will be highly repetitive!
I will admit that I am a strong proponent of Dave Ramsey. It is not because he is great with a financial calculator, it is because he is real and he knows how people should act, and how they REALLY act. Ramsey is brutally honest and he does not sugar coat anything.
If I had to guess, I would say that he is fully aware that the other methods save you about 3 - 4% more in a perfect situation. The problem is that life brings many changes and many monkey wrenches are thrown into the equation. Ramsey teaches the snowball method because he knows that most people do need the motivation.
Many of the personal financial bloggers that comment on each other’s sites know the math AND the behavior that it takes to win with finances. However, credit card debt continues to soar in America. Until this slows down, too many people need to hear a plan that psychologically works, not one that looks good on paper.
Comment by erik — Apr 18th 2006 @ 9:46 pm
The reason Dave does not do the math, and instead says attack the smallest first is simple. He states that he wants you to have “success” as soon as possible. That way you will continue and not quit. He mentions you could do the math, but by knocking off the smaller ones first you will have the percieved effect of results, sooner. Like the old saw; What we percieve… we can achieve.
Comment by greg — May 12th 2006 @ 1:11 pm
It’s seems that alot of you just don’t get it. I’m also one of these “nerds” who can do math. The math isn’t the probably…it’s the person in the mirror.
THAT is what Dave Ramsey is all about. If you still think Dave’s way doesn’t make since…ask yourself…is your way any better than what it was last year? Are you still in debt? Are you FURTHER in debt? If your car breaks down today, do you have the CASH to cover it or will you have to rely on your credit cards or borrow money from family? It’s very simple:
Step 1:
Start an Emergency Fund of a $1,000! Place in a high interest SAVINGS ACCOUNT (HSBC is 4.65% at the time I’m writing this). This is NOT investment money! Do whatever you have to do to get this money in the bank…sell un-needed items, 2nd job, etc…
Step 2:
Start your written budget.
Step 3:
Afte paying off your debt (except house) you should have plenty of income to finish building your Emergency Fund of 3-6 months. Again, THIS IS NOT FOR INVESTING! Put it in savings and FORGET ABOUT IT!
Step 4:
The next step is to get your retirement in order. 401K, Roth IRA’s, etc… Listen to Dave on suggestions.
Step 5:
Now that you got YOUR retirement in place, it’s time to start saving for the kid’s college.
Step 6:
After you have the above steps in play, start attacking your mortgage!
Step 7:
After you have paid all debt off, have a fully funded ER Fund, you are saving for retirement, you are saving for kid’s college, and the house if paid off, you will have lots of CASH to build wealth and give to charitable organizations!
It’s that simple! Just remember…it all starts with the person you see in the mirror every morning.
Comment by tammy — May 19th 2006 @ 10:31 pm
I tried the highest interest first method and got nowhere quick. I tried Dave’s method and paid off $7000 in 10 months. Like someone else said tell it to the doctor’s that I counsel everyday. By the way nickel if you have been out of debt for 35 years you can’t possibly be spending more money than you have.
Comment by jim — May 24th 2006 @ 8:53 pm
You’re right. We’re not.
Comment by nickel — May 24th 2006 @ 9:18 pm
Dave’s other bad math is his failure to distinguish between average and compounded returns. He overstates stock market performance.
Comment by Doug — May 31st 2006 @ 9:58 pm
I find Davve Ramsey to be a good motivational speaker. I have been listening to him everyday just to keep me on track. Listening to people who have paid of their debt, and are in some cases worse off than I am, is very motivational. I’m in it for the emotional aspect of it.
The way I see it either method gets a person to the place we all should be. Not being a slave to debt. Not following any method we would end up paying interest until we die. At least there is an end when we take some/any approach to paying off debt.
Comment by jason — Jun 2nd 2006 @ 9:04 am
I believe you make a good point to pay off high interest debt first. however after listening to dave ramsey for two years he suggests paying off consumer debt (credit cards) FIRST before car or student loans since they usually have higher interest. my cards have 0% for one year and 2.99% for the life of the loan. depending on peoples situation you’re both right.
Comment by gary arcand — Jul 2nd 2006 @ 9:18 am
I thought about paying off the highest interest bills first and wondered why David suggested the reverse. I believe it is because of the psychological effects and give the debtor the immediate gratification they are used to.
larry
Comment by Larry — Jul 10th 2006 @ 5:38 pm
Hi,
I’m attacking my debt vigorously, but wanted to know if there are any companies out there that will consolidate personal student loans (not government student loans). I’m always getting offers in the mail, but I don’t want to fool around with illigit companies. Can anyone help? Thanks.
Comment by Marie — Jul 29th 2006 @ 6:21 am
I’ve helped some friends allocate payments for getting out of debt and I’ve learned that the best plan differs for different people. The ideal recovery is to pay off the highest rates first. Unfortunately, if Debbie gets discouraged because she doesn’t _feel_ that she’s making progress and so goes back to just the minimum, then that plan is not the _best_. I can (and did) whip out the old spreadsheet and _showed_ the progress and explained why it was best; and she understood, but she still didn’t _feel_ like she was making progress and so began to fall off the wagon.
In her case, she mainly had lots of cards with relatively low balances (
Comment by Jim — Aug 10th 2006 @ 4:56 pm
Wow. Excellent information. Thanks for the example & coparing the different strategies.
Now if I could just train myself to take these payments and put them into a high interest vehicle, I’d be laughing.
Life has a way of getting in the way of my best laid plans.
Comment by John W — Aug 21st 2006 @ 2:44 pm
I went through Dave’s FPU back in the Spring and since then I have paid off almost $10,000 in debt. But debt isn’t the only issue you need to deal with in order to ‘win’.
In my opinion (like buttholes, everyone has one) debt seems to be the primary issue the mathmaticians are focused on. Not only have I paid down debt, but my marriage has turned around. My wife and I no longer fight about money, because in FPU we not only learned the ‘debt smowball’, we learned how to budget, invest, buy a home, and most importantly how to talk about money.
The emotional and spiritual value was worth every penny the church paid. It wasn’t even our church. I’m a computer programmer/analyst and my wife is an accountant. So now everyone knows at least one broke accountant and programmer. But we’re now on track. People scream “I’m debt free’ almost daily on the Dave Ramsey show, so his plan seems to work for a lot of people.
Comment by Danny — Aug 22nd 2006 @ 11:25 am
I can say that I never listened to Dave Ramsey. I did visit a messageboard (YourMoney on MSN.com).
I started whittling away at our debt by getting rid of the smallest ones first, and budgeting for 2-3 years (which can change … so it’s in a spreadsheet).
Since I had control of the cash flow, I started focusing on the rates for the remaining credit.
Today my wife and I have no debt outside of our mortgage, and that’s been moved down to a 15 year mortgage (with only 13.5 years left).
Now it’s time to start building retirement savings up!
Comment by Chris — Oct 6th 2006 @ 10:50 am
I’ve listened to a handful of Dave’s podcasts. He must be motivating for those who continue to listen, but I personally find his “strong father-figure” demeanor boring.
I can see how the psychological effect of dropping payments can be enticing, but I worry that he’s only partially educating his audience.
I’m not too excited that he manages to bind money and his religion. It must appeal to his audience. But for me it only brings back bad memories of the 1980s. Besides, I vaguely remember some story about throwing the coin counters out?
Comment by John — Oct 16th 2006 @ 7:56 pm
I agree with the math of your article, and so does Dave Ramsey very often on his show. This is the best approach, and the approach that most people generally go for. But as Dave Ramsey says on a daily basis, most people are broke. 70% of americans are living paycheck to paycheck, and most divorces have labeled money fights and money problems as one of the primary causes of their split.
Dave Ramsey takes a motivational approach to debt. Many people attempt to pay down the largest-interest-rate debt more quickly, but because life happens, they often give up because it takes many months to see any progress. However, by using Dave’s approach, you can generally knock out a couple small debts quickly, freeing you up a couple of payments, and giving you a quick sense of financial peace knowing that you have more money to work with.
As you keep with the program you keep knocking out debts, and even when life’s little emergencies happen, since you have that extra cash left over, you will be less likely to panic and do something that you will financially regret (such as putting it on a credit card or taking out a loan). Also, since Dave advises keeping a small emergency fund of about $1000 around for emergencies before starting the debt snowball, you have that kind of buffer zone for unexpected expenses.
Eventually, as you keep killing off more and more debts, and crossing them off your list one after another (my wife and I have them written on our fridge and cross our debts out as we go with a big red marker), the snowball will continue until your debts are paid off. At that point you have access to your greatest source of wealth, your income, and you can begin investing in your future and family.
Dave’s approach is not the quickest way to pay off debt for sure. So why is it that he is so popular? Because he realizes that personal finance is often more “personal” than it is “finance.” We’re not talking about a Fortune 500 company here, we’re talking about individuals. We’re talking people who from day one have a personal interest in what happens with their money. Because of that, we must keep in mind the fact that if we don’t cover the “personal” side, the “finance” side generally won’t work out.
Your strategy is mathematically sound. And many people get out of debt this way as well. But instead of pushing against a grindstone for four to six years before I finally see my first evidence of results, I’d rather get on a plan where I can quickly and effectively get myself out of debt, and *see* it happening at the same time.
It’s the way your grandma would have done it, that is, if your grandma borrowed money. But unfortunately for us many of those values of our loved ones who passed on before us, such as saving for emergencies, paying back what we owe, and not spending money we don’t have in the first place, have been lost. And if it takes some middle aged bald guy from Nashville to bring those values back, I’m all for it.
I wish you guys luck in whatever way you decide is best to achieve financial fitness.
David “Serophis”
Kentucky
Comment by Kyle — Nov 3rd 2006 @ 8:30 am
Apparently I have been living under a rock as I have just found Dave Ramsey. I do not have ANY credit cards; I am buying my house on land contract, and can barely afford my utility bills. I work over 50 hours a week, as does my partner. We have a budget but it seems not to get any easier to save money, let alone get $1,000 ER fund. We do not have a home phone; I haven’t bought any new “toys” (DVD player, laptop/computer, MP3, etc…) in over 2 years and NONE of our spending is extravagant.
From what I’ve seen (admittedly very little) of Dave and others like him, they will give me the magic to fix my finances, but at a price. I don’t begrudge him the opportunity to make money, we all have to make it somehow, but if I can’t afford my gas bill, how am I supposed to buy his advice?
I am not very good at math, but I do know, if I have monthly bills that are more than my monthly income, saving money is a stretch. Changing jobs is not an option, unemployment in my area is over 20%, my degree when I got it was above entry level, but now IS entry level and less money than I make now. Does anyone know of a plan for lower middle class working people to gain their financial peace?
Comment by Kelly — Nov 8th 2006 @ 4:51 pm
Kelly,
It doesn’t matter how much money you make, if you spend it all. You say you have a budget, how does that compare to your monthly spending? You both may have to resort to recording your every expense in an expense book to find out where your money is going. Write down in a notebook every meal, drink, etc you spend throughout the day and see how much you’re spending all day. It could be you’re spending too much eating out, buying name brand clothing, partying, etc, because unless your living in L.A. or N.Y. having no debt but the house and land, you should have something left over unless you’re both flipping burgers. Are you “house poor”? Is the house/land payment over say 40% of your income?
I know you’re not good at math, but it’s a simple income/outflow calculation. If your outflow is too high, you have to either try to reduce spending, or increase your income. If you’re in IS, the market is better now than it has been in several years. Talk to some recruiters.
As far as Dave’s advice, have you tried his book? It’s cheap and that should get you started.
Good luck.
Comment by Paul — Nov 14th 2006 @ 2:48 pm
Hey, Kelly, I just finished reading your comment. I know that Dave Ramsey would never advise you to spend money on his book that you normally would have spent on food; and I’m not going to, either. However, seeing that you have an internet connection you should be able to glean a great deal of info off of his website, as well as through related searches on the internet.
One piece of advice I will give from his book is to become what he calls “gazelle intense.” Essentially, you use the same mindset as a gazelle grazing in the field while attempting to avoid danger. When a gazelle senses a threat, you won’t see them all start to run in different directions. Rather, they will perk their heads up, look around, and assess the situation. Only once they can see and understand the danger (normally a cheetah or other predator) can they attempt to avoid and escape it.
In your situation, your enemy is debt. If you are like many where I live, you have fallen prey to a lender who agrees to give you a high-interest-rate home loan when you otherwise wouldn’t have been able to be approved for it. As a down payment, you had to put your land down as collateral.
These types of lenders generally target people who are just starting out or who have had credit problems in the past, and purposely give them loans they know that the people cannot afford. The second that the buyers make a single late payment of even a day, the company rushes to post negative reports to the homeowner’s credit bureaus, quickly ruining their credit and destroying any chance of refinancing in the near future.
THe first thing that you need to do is assess your situation. You don’t appear to have much debt other than your house, but the house is definitely an issue. First thing you must do is create a monthly budget, listing your debts and other monthly bills. As you are in a tight financial situation, you must prioritize your spending in a matter of importance. First, you will always choose food, and ensure that you set aside enough money for food for your family. Don’t even think about giving your creditors money while your family goes hungry.
Second, you want to pay for utilities, your home, transportation, etc. Things such as cable TV, phone, etc. are unnecessary, and if you have money left over you can spend it on these, but ONLY if you have money left over.
If you can keep your budget together and STICK TO IT you will soon begin to see some progress. You want to get that emergency money together as soon as possible, and then put it away where you can’t “accidentally” spend it (for example, moving it from your checking account balance to a savings account, so that you have a little bit of time to rethink those spontaneous spending decisions you would have otherwise made).
One piece of advice my wife and I found helpful: budget your money on paper, and find out how much is going to be “left over.” This leftover amount is not actual surplus; rather it is all going to go towards your emergency fund, and then eventually to your debt snowball. You then want to take this “surplus” amount, and take it out of your checking account at the start. If you leave your emergency fund money around, even just until the end of the month ‘just in case,’ you’ll end up spending some or all of it. Instead of thinking of your leftover cash as a buffer, immediately put it into your emergency savings account so that you won’t spend it.
After you get that emergency fund saved up, you’ll want to tackle that smallest debt you have. Maybe it’s a small loan you took out, maybe an old cell phone bill, maybe even some money you borrowed from your parents during a tough time. After you’ve taken care of that debt completely, you need to start with the smallest remaining one.
Unfortunately in your situation it doesn’t seem like there will be many small debts you can take out. At this point, depending on how crucial your situation is, it may be time to look into selling your house. I know that this is not an option you want to take lightly, but at the same time if you’re going to lose it because you are unable to make the payments, then better for you to have it sold under your terms than at auction where you will be liable for the remaining balance.
Even if it means renting for awhile, saving up some extra money, and recouping your financial situation, you can do it. Whatever you do, don’t give up; hang in there, give your family lots of extra hugs and reminders of how much you love them–because I guarantee you it’s going to be a stressful time for them as well. Stick to the free advice on Dave’s website, and also find peers who are Dave fans where you live and listen to their advice–and I guarantee you that you will eventually make it out of this, stronger and more confident than when you started.
Comment by Kyle — Nov 20th 2006 @ 12:43 pm
You may say Dave is bad at math but you are bad at English!! Notice this excerpt of the above “As outlined in The Automatic Millionaire, this approach is based on the ratio of the outstanding balance to the minimum amount do.” Shouldn’t that be “minimum amount DUE”?
If you listen to Dave explain why he likes using his method and the “atta boys” it gives I can see why some would prefer his method even though it may cost a little more in the long run. The main thing is that you are doing something positive to get out of debt.
Comment by Bill — Nov 22nd 2006 @ 3:30 pm
Comment by nickel — Nov 22nd 2006 @ 6:53 pm
Kyle and Paul,
thanks for your comments. I know I need some help, so any and all comments really appreciated. I do have a budget and a plan.
I have a spreadsheet set up with a calendar for each of mine and Meladee’s pay periods. I total it up for a weekly or by weekly total. Then I list all bills that are due that week or before the next pay dates.
For example:
week of 11/24
Kel pay: (for 2 weeks average) $900
Mel pay: (weekly average) $250
Total income: $1150
house: $690 due 12/1(actual; includes escrow, loan and insurance)
electric: $250 due 11/27(past due amount)
gas: $100 due 11/28(estimate)
water: $75 due 11/21(estimate)
total out: $1005
Balance: $145 for groceries & gas for the cars till Mel gets paid again the next week.
I have the weeks planned out for the rest of the year and into Jan. I try to plan for special occasions, like Christmas, birthdays, that kind of thing at least a month out to make sure we are not scrambling last minute and more apt to send more money because of it.
These are actual amounts. If we don’t use the whole amount left over, we save it for the next week.
As for the house, we JUST bought it in July from the owner on land contract. We put $5000 down and are paying the current mortgage and will have to purchase it outright with in 5 years. Total price $80,000. the neighbors just sold their house last week for $120,000, so the price is not out of whack. We were renting and had been for the past 5+ years. We both felt that it was time to buy and not spend money on rent with nothing to show for it. Our monthly payment went up $75. We got the $5000 from a workers comp settlement I had last year. The rest went to past due bills, family we borrowed from and the move to the new house. That took up all of the settlement. It may not have been the smartest move, but neither of us knew what else to do with the money, we though it was a good move to buy a house.
We both buy clothes at Walmart when needed, we have to have internet access, we have 2 boys in high school and a daughter in middle school and it’s part of their homework.
We both take our lunch to work and cook dinner at home. Once a month we have take out pizza or some other fast food. We both feel the need to make sure we do something once a month for ourselves. We both think it helps keep from getting depressed about our finances.
The only thing I can see to get us started, is to use a % of what’s left over in the ER fund and the rest for the next set of bills. Any ideas??
Comment by Kelly — Nov 24th 2006 @ 5:41 pm
This article evaluates loan size, loan payment, and interest rate. It is missing three things, emotion, loan type (revolving) and minium payment percentage. These matter because Discover only requires 2% payment per month and visa usually is at 3 or 3.5%. If you pay the highest minimum payment percentage first you will pay the grand total off quite a lot faster. I wrote the spreadsheet, I know. HOWEVER, ALL OF THIS DISCUSSION IS WRONG because people who are in debt need to see progress and they need to see it FAST. Debt elimination is like loosing weight, some quick results will have more lasting impact than saving $300 over 2 years. Steve N.
Comment by Steve Nelson — Nov 27th 2006 @ 3:35 pm
Kelly- right now Dave’s book is on sale for $10 on his website. Also his classes are available at alot of churches and some churches have “scholarships” available to help defray the cost. Or call into his show- alot of times he will give the callers a book or put them through the class for free.
Comment by Deb — Nov 27th 2006 @ 9:24 pm
You have to understand the value of his approach. He is treating the debt as a addiction. The drastic speanding calls for drasctic measures.
I had the same problems after college and considered the DR method, but the math didn’t work for me. I do understand the concept, some people need immediate reward to keep them on track.
Comment by Michael — Nov 29th 2006 @ 3:09 pm
Kelly,
I’m not a mathematician either, but if your income is $900 for 2 weeks thats $1800 a month and your wifes is $1000 a month. That is $2800 a month total. Your mortgage and bills (totaling $1115) are only once a month, shouldn’t that leave you with $1685 a month?
Comment by the lion — Dec 1st 2006 @ 1:42 am
Kelly,
As to your question about putting a percentage of what’s left over into a place to pay part of the next round of bills…
I assume that you are currently working on a weekly or bi-weekly payment system, in that you try to budget on a weekly, not monthly, basis. What I would suggest (although it often gets difficult starting out because of the many factors, including odd pay, money moving from week to week, past due amounts, etc.) is trying to move to a monthly system.
For example, my wife and I are paid exactly twice a month. However, our electric, mortgage, phone, and other bills generally come around exactly once every month. We may have to pay some things at the start of the month and others in the end of the month, but they happen once a month nonetheless.
For this reason, we will generally make two budget layouts. The first is a monthly budget: basically, a list of all the money we make, and all the things we have to pay this month. This is your worksheet and where you will make your big decisions and calculations. If your house is due on the 1st of the month, make sure you pay it at least by the 30th, so that it shows up on the month you’re working on (if you get paid on the 15th and not thinking about it, schedule your house payment to be paid by that check, you’ll end up paying it 14 days late).
After you get everything set up and see that the numbers work out on a monthly basis, you want to sort it out on a per-check basis. While you’re living paycheck to paycheck you’ll have to do this carefully; after you have a bit of a buffer saved up it won’t be as much of an issue.
EXAMPLE:
Monthly income: $3000
House: -800
Electric: -250
Water: -75
Food: -500
Transportation: -200
Phone: - 90
Internet: - 45
Now we’ve got the monthly part out of the way, it’s time to figure out how to pay it. To keep you on your toes, I’ll pretend that the people in this example scenario are on different pay schedules: one of them gets paid once a week, the other every 2 weeks. We’ll use mine and my wife’s name as examples as well.
Paycheck 12/7: (Ashley’s check)(remember to make sure your check will clear by the date that you write here so that you don’t have to worry about bounced checks)
Total On Hand: $250
Food Budget: - 125
Car Gas: - 25
Car Repair Fund:- 25
————————
Left Over: $ 75
Checks 12/14: $750 (500 Kyle, 250 Ashley)
Prev. Balance: $ 75
Total Available: $825
Food Budget: - 125
Car Gas: - 25
Car Repair Fund:- 25
Electric: - 250
Water: - 75
Phone: - 90
Internet: - 45
———————-
Left Over: $ 190
Check 12/21: $250 (Ashley’s 3rd check)
Prev. Balance: $190
Total Available: $440
Food Budget: - 125
Car Gas: - 25
Car Repair Fund:- 25
———————–
Left Over: $265
12/28 Check: $750 (500 Kyle 250 Ashley)
Prev. Balance: $265
Total: $1015
House Payment: $ 800
Food Budget: - 125
Car Gas: - 25
Car Repair Fund:- 25
Emergency Fund: - 40
———————–
Bottom Line Total: $0
Note that although just the house payment alone is more than we would bring in in any given paycheck, but because we kept that money available from the previous week, we were able to handle it. Also note that the $40 that would have otherwise been “leftovers” was counted as an actual expense to go to the emergency fund.
Although this theoretical situation doesn’t give much wiggle-room, it shows an example of how even a couple in a very tight cash situation can make it as long as they plan ahead. Remember, plan it out before the month begins, make sure to take everything into account (my wife and I have been planning for the expense of Christmas since September, and that’s even taking into account that since we work on Thanksgiving weekend, we get enough holiday pay to pay most of our expenses. Remember that every month will be different; you’ll have to buy a turkey in November for thanksgiving; you’ll have to pay more for fuel in the winter, and you’ll have to fix some random thing on your car at some time (see the $25/week Car Repair fund? Since (hopefully) your car doesn’t break down each week, you basically get to put this money in an envelope until something does break, so what would have been an emergency becomes a mere inconvenience).
I very much believe that you can get through this with a little bit of concentrated effort. Since you don’t really have that big of a credit card/debt problem that I can see (other than the house), the biggest thing you have to change is your behavior. Instead of seeing your expenses as a weekly thing, think of the amount you make each month, subtract it by the bills you pay each month, and look how nice that number looks. It doesn’t matter that you spend almost every dollar of your paycheck in a particular week, as long as on a different week you have a lot left over.
Please feel free to ask us any questions you may have; I’m not on here all that much but when I am I’ll try to answer as good as I can. Remember: I’m no expert here; we’ve got credit cards, car loans, and other ghosts from our past that we’re still paying for. But consider us as your support system–people that used to be normal, just like you and everyone else, but decided to be abnormal and weird, forsaking the joke that is the ‘credit score’ and instead turning toward the simplicity of ‘If you spend less than you make, you’ll have money left over. And if you do that your whole life, you’ll end up with a LOT of money left over!’
Keep at it, whatever you do. It may take one, two, or six months to get everything caught up and get ahead again, but as long as you make sure that every single cent you bring in works for you (ever notice how the leftover money in your bank account seems to disappear? It’s because it doesn’t have a purpose in life. If you don’t tell money what to do, it’ll go do its own thing; whether it goes and buys a DVD, gets some fast food, etc. But if you have all of your money split up and assigned into categories depending on when and how it’s going to be spent, you won’t have anything left over to waste. Remember that if you leave the leftover cash in the “Total Left Over” category on your budget, then money is much more likely to disappear. But if you look at your budget and see that you have zero dollars left over, you will completely forget that you put that 100, 200, or more into an emergency fund. In your mind, the money is gone, along with all your bills. And since it’s gone, you won’t spend it, and you won’t even know it exists until you do a budget again next month and have the peace of mind in knowing that all that leftover money is sitting safely tucked away in case of an emergency.
Comment by Kyle — Dec 4th 2006 @ 2:21 am
I still agree with Dave Ramsey because if someone is drowning in debt, it means that the person has problems paying debt. Otherwise if the person can pay the big debts off without a problem. They are OK, they don’t need financial counselling but for those who do need financial counselling then starting from 1st Grade(Dave Ramsey’s way) is better than starting from 1st Year of College (Your way).
Comment by Frederick Bvalani — Dec 4th 2006 @ 8:51 am
Stupid idea for most people. I have been in bad debt before, trust me when I say I am not good at math. If I were capable of doing your formula then I might not be in debt to begin with. Keep it simple if you want to be succesful.
Comment by Scott — Dec 4th 2006 @ 12:21 pm
You’re totally right. I have long wondered what Dave Ramsey was thinking. If several people are ripping you off it only makes sense to fire the ones who are ripping you off the worst, first.
I can only assume that DR is targeting his plan to people who inherently don’t have much discipline and therefore need the psychological boost of paying off a little bill or two.
Greg
Comment by Greg — Dec 13th 2006 @ 12:39 am
My wife and I are starting Dave’s plan January 1, 2007. We have paid cash for Christmas, so we are not adding to our debt except for added interest.
My point of writing is that it doesn’t matter witch method you use “highest interest rate”, “lowest amount”, or “hang your bills on the wall and throw a dart at them”. It is that you do something and get control of your money. Personally Dave’s “debt snowball” will be a huge motivator, but is all about changing behavior.
Great posts.
David
Comment by David — Dec 17th 2006 @ 11:41 pm
Great comment, but I think what Dave is doing with the “snowball” is giving people motivation and hope. Beacuse paying the lowest balance debt first give you the feeling that you are making difference, that you are in control and also give you results… Happy wealth and debt free holydays!!!
Comment by Roberto — Dec 18th 2006 @ 10:01 am
Ramsey has said on multiple occasions that mathematically, yes you are correct. His main point on working the ’snowball’ is more about the power of personal focus, than the math behind paying of dept.
Yes, you save money by paying off the highest interest rate debt first, but you’re missing the psychological reward of not having to cut a check for those trivial debts month after month.
Comment by Jon — Dec 27th 2006 @ 3:57 pm
You know, I’m just glad to finally see anyone question Dave Ramsey. With the possible exception of his debt reduction strategies, his financial planning advice is very superficial.
Comment by C.M. — Jan 6th 2007 @ 8:48 pm
If Math was our problem we wouldnt be in debt in the first place.
Our spending behavior is the problem. Therefore the snowball is designed to slowly modify spending behavior.
Comment by jet — Jan 10th 2007 @ 10:10 am
It is clear that you are looking at this as just a math nerd, not as a real person with money issues. You also forgot to complain that he has you save 1000.00 first. You are only getting about 3% intrest on that if you are lucky. So that should have been a issue for you to complain about as well if you had actually looked at his whole plan. To start with if a person was math smart they never would have used the credit card and got the balance to start with so to me right there blows a lot of your math. Dave’s plan is about changing your life style a little at a time so you don’t give up. No different then quiting smoking with a aid instead of quiting cold turkey. You have a much better chance of making it all the way a little at a time. His plan has worked for countless families which if you would read his book and listen to his show you would know.
Comment by Brian — Jan 12th 2007 @ 11:08 pm
The best part about this blog is people are getting emotional about paying off debt … who cares which way!
I will say that the example is flawed in multiple ways (as academia examples usually are):
1) As one person stated 3 debts with only high balances are probably not very real world examples, more likely a smattering of a high and low balances and probably not many good interest rate cards. When you have a lot of debt and a high debt to income ratio you won’t get many offers for low interest rate cards, just more high rate cards. The only way I could see having a large mix would be to have a good loan rate and VISA/MC rate and then high department store rates. As my creit score got better that was my experience. When I was younger and swallowed by debt even my car loan rates were high because I was a high risk.
2) The strategy says to pay minimum balances: which means that credit card minimums will change as the balance is decreased (I think I remember Sears’ interest rate went higher with a lower balance but that was long ago). So with just the Visa example it would take 259 months to pay it off just by paying a minimum of 2.5%. I did not calculate the difference because as others have stated being debt free more than makes up for a potential ~$600 savings and if they stick to any plan then God bless them!
Sorry for rambling
Comment by Mark — Jan 13th 2007 @ 12:33 am
> This isn?t to say that an approach such as Ramsey?s isn?t worthwhile. For example, under Ramsey?s scheme, the first debt gets knocked out very quickly, and some people may need that psychological boost to keep at it.
> But for people with sufficient self-control, you can do better by paying off debts from highest to lowest interest rate. Then again, maybe people with self control don?t get into debt in the first place?
The lack of control stems from a lack of education early in life. Please don’t spoil your kids and show them discipline.
That’s why Dave does one method, it keeps everyone focused. I wasn’t hooked on his solution until I heard people calling in saying they are debt free.
He offers every aspect of psychological stimulation- results out of the gate, and results of people calling to his 300 station strong (and both satellite companies) radio program every Friday telling their success stories.
It’s Dave Ramsey for me.
Comment by Steve from Yellowstone — Jan 15th 2007 @ 9:17 am
Kelly - I don’t see what your problem is. You have monthly income of $2800 and expenses of only $1000. What in the world are you doing with the rest of your money? $1800 is a lot of money to just let slip through the cracks. Even with a $400 food + misc. allowance, you still can’t account for over half your income. That’s pretty bad. Plus, Mel needs to get a better job and/or work more. $250 a week is minimum wage.
As for the rest of you nerds, who really cares? The difference between the optimal “math” scenario and the “debt snowball” is only $641 over 27 months! Do what works for you. You’ve spent so much money on interest on $26,000 that the $640 is trivial. You guys probably get real excited about the 1% cash back on your 15% interest Discover card too.
Sheesh. You whiners sound like those new parents that think their kid is better than others because he learned to walk a few weeks before the other kids in the daycare … like he’s going to walk better than everyone else when he grows up.
This whole discussion is pointless. Get out of debt as fast as you can. Then build wealth. Then live happily ever after.
Comment by David — Jan 26th 2007 @ 4:38 pm
Kelly:
If you don’t want to use food money to buy Dave Ramsey’s books, go check them out from the library and read it through a few times before the due date. There. You’ve gotten access to Dave Ramsey without paying him a dime.
I agree with David that this discuss is pointless. I think you have to go with the method that is going to work for you. A lot of people are not only living paycheck to paycheck, they are living beyond their means and have creditors on their back. DR gives them one method to dig out from that hole. He gives us all a shovel with which to dig.
I wasn’t at the point where I couldn’t make payments on time when I found DR, but I WAS at the point where the minimums plus my expenses were taking every dime of what I had every month. There was no room to give. Because I’m stubborn and think I know better, over the past two years I’ve tinkered with DR’s system a few different ways — mixing in David Back and Mary Hunt, and my own ideas.
I firmly believe my tinkering has slowed down my debt repayment. I do think it’s better to choose a plan and stick with it, but not everybody can do that.
I can’t tell you where I’d be if I’d not tinkered with DR, but where I am is a car payment and a credit card paid off, and over $10,000 in debt paid off. Plus I’ve saved nearly $4K, started a Roth IRA, continued contribuing to my 401(k), AND, perhaps more importantly, I now pay every bill I have in the first few days of the billing cycle because I’ve got my payment timing down, and always have $100s left to apply to the snowball. Plus, borrowing a page from Mary Hunt, I set aside money every month to budget in irregular expenses like auto and renters’ insurance as well as car tags. I pay those things easily now and in full when it comes, saving on fees.
Every month is a struggle for me psychologically though (I’m doing this all by myself), and I fall off the bandwagon spending-wise from time to time. What always pulls me back in is recommitment to Dave Ramsey’s snowball.
Dave Ramsey plus Mary Hunt taught me how to live on a budget, and how to master a budget.
That matters more than making the math work.
Comment by gmv — Jan 28th 2007 @ 11:51 pm
Hmm, it would seem to me that at the end of the day as long as you at least start to pay down your debt without incurring more debts you are well on the way. Whether you pay it off 1 month quicker I think is pretty irrelevant in the grand scheme of things.
Comment by BigBuddha — Jan 30th 2007 @ 11:43 pm
The above statement is complete nonsense. In the example above $1000 at 20% is $200 per year. $10,000 at 20% is $2000. Together you have a total debt of $11,000 and total annual interest payments of $2200.
Assuming that the you’re paying in a fixed amount ($500) monthly, and the rates remain the same between the different creditors, you’ll pay down the same amount regardless.
You owe $11,000 at 20%. Period. It doesn’t matter if it’s divided $11,000/$0 or $7,000/$4,000 or $3,000/$3,000/$5,000.
At the end of the year you will have paid off the same amount of money; you will have accumulated the same amount of interest and you will have the same remaining balance.
It looks like Dave Ramsey isn’t the only one who can’t do math.
Comment by David — Feb 5th 2007 @ 11:34 am
To all of you guys trying to be really smart, Dave is 100% correct! I never heard Dave say that his way is the best way to save money on high interest rates, what he says is his way is the best way to stay motivated. Most people who are finacially lost need motivation to stay focused. Pay attention to the message and stop analizing!
Comment by debtfreedude — Feb 8th 2007 @ 2:57 pm
I’d have to agree with debtfreedude.
It’s about motivation - sure, most of us have done the time-math part of it, and in the end, it all pays out in about the same amount of time.
But instead of seeing 3, 4 or 5 debts (or more) for month after month after month…you see 5 then 4 then 3 then….well you get the picture - out of sight, out of mind and finally out of your life!
Remember, one of Dave’s sayings is ‘personal finance is 20 percent knowledge and 80 percent behavior.’ I can say, seeing debtors names off my checkbook register and bank statement assists in maintaining a behavior of getting out of debt!
Comment by depperson — Feb 9th 2007 @ 11:34 pm
so, since the guy posting this is so great with math, hows your financial life dude?
you debt free? no payments? or does the bank and mastercard own you and your life?
Comment by DR fan — Feb 13th 2007 @ 7:52 pm
You’ve got to find a method that works best for you. We tried the highest interest thing for years, but it wasn’t until we started listening to Dave that we actually made ANY progress in paying off our debts. That progress was due solely to getting on a budget and following the debt snowball. We’ve been debt free(except for the mortgage) for a year now, and we now have 3 months of expenses for our emergency fund. Dave’s plan works!!
Comment by Another DR fan — Feb 13th 2007 @ 8:07 pm
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