Q&A: Dave Ramsey and Debt Reduction

A reader recently wrote in with the following question:

How do you feel about Dave Ramsey’s program? I am in horrible debt and want to become debt free in the next 4 years.

That’s not a lot of information to go on, but here’s my response…

Dave offers some pretty sound advice in the form of his so-called “Baby Steps“:

Step 1: Save up $1, 000 to start an “Emergency Fund”
Step 2: Pay off all debt (except the house) using the “Debt Snowball” (smallest to largest)
Step 3: Save up three to six months of expenses in savings
Step 4: Invest 15% of your household income into Roth IRAs and pre-tax retirement accounts
Step 5: Save up college funding for your children
Step 6: Pay off your home early
Step 7: Build wealth and give! Invest in mutual funds and real estate

My biggest (and really only) criticism of Ramsey’s approach to debt reduction has been that his Debt Snowball doesn’t make good mathematical sense — the better approach (from a purely mathematical standpoint) would be to pay down the highest interest debts first rather than focusing on the smallest debts first.

This being said, killing off small debts first give you an early taste of success and keeps you hungry. If you need this sort of psychological boost to stay the course, it’s probably better to take Ramsey’s more conservative approach.

In the final analysis, there really isn’t a wrong way to pay off debt. The most important thing is to simply get started.

This article is part of my Money Q&A Series.

18 Responses to “Q&A: Dave Ramsey and Debt Reduction”

  1. Anonymous

    In response to Scott RE: Dave’s $1,000 emergency fund. This is Dave’s recommendation until you have paid off all your debt EXCEPT the mortgage. Then he says to do baby step #3 and save 3 to 6 months of an emergency fund. This should then cover you during any short term disability. He also advises on obtaining long term disability coverage. To summarize, the idea is to save only $1,000 at first so that you stay “gazelle intense” about paying off your debt in order to get to the 3 to 6 month emergency fund.

  2. Anonymous

    I understand what Scott is trying to say but keep in mind that alot of people have absolutely NO savings and as such minor things like car repairs, a busted water pipe or a $500 insurance deductible will force them to use credit cards for those “emergencies”. Having $1000 to cover that is better than having no money at all.

    Now I don’t follow the Dave Ramsey plan but it does make sense. He should then call that step “Building your life hic-cup fund” which is what those type of things are.

  3. Anonymous

    As far as all this “common sense” goes, does anyone realize that $1000 is not a good emergency fund? If you follow the Dave recomendation on your DI insurance of a 90 to 180 day elimination period( time of disability before you can FILE a claim-there will be processing time of around 30 days after that)- then how long will $1000 last? No argument can counter the fact that if you don’t have adequate savings and you face an emergency- the plan will fail! Don’t forget that amidst all Dave’s “cuteness” is a man who has made millions from selling this plan. Don’t become infatuated with debt reduction to the point of stupidity.

  4. Anonymous

    I have to admit that “Getting Started” is the hardest for most people.

    It’s something like a denial syndrome, especially when the debt amount is “astronomical”.

  5. Anonymous

    I owe about $130k with cc, mortgage and car..

    I designed a snowball spreadsheet that can run various scenarios such as high interest or typical snowball.

    The difference between the two?

    $100 in interest!!!

    I’ll do the snowball as it makes me more motivated to see the debts drop off. Besides I’ll save more on stamps at 40 cents each!

  6. Anonymous

    It might be worth noting that steps 4, 5, and 6 are all done simultaneously. Dave also discourages people from being tempted to do the steps out of order. In other words, if you are in debt, you should not be contributing to your retirement until you are out of it.

  7. Anonymous

    Technically, step 4 is to save 15% of your household’s PRE-tax income in retirement accounts. First contributing to your 401(k) to any match and the rest in Roths until maxed out. Then any more money should go into the 401(k)

  8. Anonymous

    My husband and I are working a Dave Ramsey snowball right now. Husband wanted to go with a plan ranking the debts by the interest rate and I wanted to work the plan, I won out but out biggest debt ($27,000 in student loans for husband’s MBA) had a low interet rate of 3.5%. It was very motivating to pay off 7 of our 8 debts in six months. Its been slow but steady going on the last debt.

    I like Ramsey’s plan and agree that the emergency fund is key to getting debt paid off. The other key, which is part of the debt snow ball step, is not adding any additional debt (cut up the credit cards). But, the bottom line is to figure out what works for you. We are following the plan in general but we both continue to max out our 401K, we would likely be debt free already if we were not investing in our funds. But, we need the tax shelter and it was important to both of us to continue to make that investment. We also tried to stick with only using cash for spending and we found that too hard to track. As a result, we mostly use our debit cards for day to day spending and some cash (no credit).

  9. Anonymous

    @ Swamproot

    My husband and I also add a little bit to our other debt repayments. Just $10-15 or so, but it makes us feel really good. After all, Ramsey’s program isn’t just about paying off debt, but about getting all excited when we pay off debt and doing it as quickly as possible. I think your modifications sound excellent. 🙂

    I posted about all of mine in Mrs. Micah’s Modified Money Makeover.

  10. Anonymous

    yes, mathematically it makes sense to pay off the higher interest rates first. But it also makes sense mathematically not to incur high-interest debt in the first place! If the math didn’t influence people not to incur the debt in the first place, why would they depend on the math now?

  11. Anonymous

    I’ve joined his cult and drank the Koolaid. But not so much that I don’t deviate from it where I would rather. I don’t really have much debt though (~$5000 on CC, 12000 on my car). Where I deviate:

    1. There is no way I’m going to stop my Simple-IRA contributions and give up my match. Dave says don’t take advice from broke people, but my non-broke father told me to sign up for it and forget about it, like taxes and social security, so I think I can justify that. But I have a pretty small hole to dig out of.

    2. I got my car pre-Koolaid and I might take more than two years to pay it off (Dave’s “Sell the Car” indicator), but it’s THE Jeep Wrangler that I have wanted since I was a very young boy and I didn’t buy it new nor am I upside down in it. But it will be the last vehicle I ever buy on payments.

    3. I pay extra on my house even though I’m not out of debt. My wife and I fell in love with a good size 2 bedroom house that was about 40 or 50 thousand less than what we were originally looking for. The beginning 15 year mortgage balance was a mere 100% or our income, as opposed to the %200 I see as “the norm”, and the payment is 12.5% or our take home instead of the usual 25%. So I have no problem with making the extra payment because I could have easily gotten a lot more house payment and be in the same boat.

    4. I have my own “minimum payments” that I derive by calculating what it would take to reduce the “bigger snowballs” by $100 dollars each month that is a little more than the cc’s mins. I feel I get a better psychological boost by having those other debts go down by a noticeable amount while I am “attacking” those smaller debts.

    Another good deviation that I read on Get Rich Slowly or The Simple Dollar was something like the “Conservative Debt Snowball” or something like that where they paid minimums but put the money that should go to the smallest debt and stick it into a savings account until there is more than enough to pay it off in full. They then pay it off in full and then do the same on the next. They were concerned more about the potential for emergencies cropping up bigger than their Baby Emergency Fund. I think Dave would disagree with this approach because fear is a strong motivator to keep you focussed.

    I also think Dave probably say that I am detracting from my own “intensity”, but on his show he often treats such “heretics” gently as long as the caller has a plan that they can stick to and one that works for them. Having a plan (that will work) and the focus to implement it is the important thing (gazelle intensity).

    Now, I probably wouldn’t say all this on the myTMMO message boards, cause those guys are REALLY crazy about rigid adherence to the babysteps. But it does make a good roadmap to financial peace if you are willing to sacrifice now for a better standing in the future.

  12. Anonymous

    Dave Ramsey’s outline basically fits my situation, so I’m using it. Fortunately, my smallest debt was also the highest interest. In fact the debts all line up nicely that way. So we got the psychological and the actual advantage. Otherwise, I would have done it by interest because I like math.

    One of the biggest critiques of Ramsey is his advice not to put money in the 401(k) while paying off debt. But for people paying off long-term debts, he recommends saving some money in a 401(k) and enlarging the emergency fund and such even as we’re mostly focusing on our debt snowballs.

    I think he advises against it as a general rule because most people using his method can pay it all off in a year or two. But for those of us with low income and high debt, it’ll be years so we should take advantage of the interest.

  13. Anonymous

    Dave’s advice is great for SOME people, not everyone.

    If a debt pay-off strategy comes down to using the Debt Snowball and sticking to it versus a traditional, higher-interest first, and not sticking to it. Math will favor the snowball.

    It’s like buying a lawn mower. The extra money to buy a self-propelled mower in stead of the push type does not make mathematical sense, but if you’re more likely to get up of the couch and cut your grass because its easier and appears like a less intimidating project, you gladly pay the difference.

  14. Anonymous

    My first response to the snow-ball was, “no pay the highest interest first!” Then I tried to figure out what the interest rate was on each with some having different schedules of compounding. Plus Erin’s case of the smallest amounts corresponding to the highest interest is at least common enough that you can just assume that except for credit cards versus car.
    And here is the deal-breaker the cost of the stamp each month is often more than the difference of the two percentage rates. The cost and time required for paying a bunch of little bills makes it better to get rid of them quick.

  15. Anonymous

    I am doing the higher-interest first path, but I do agree with Ramsey that low balances should be paid first. You have to be pretty well disciplined to keep on track when you are paying off your largest debt first. Sometimes even I feel like I’m not getting anywhere, but of course I am. That feeling of accomplishment is probably essential to most people.

  16. Anonymous

    I’m a dave ramsey fan. I will say you are right about the math when it comes to his snowball method. For us, all our interest rates are super low, and just happen to rank in order of highest to smallest along with the amount of the debt. So we would pay them off in this order anyway.

    I think the psychological part of paying off debt is huge. That’s evident by the large amount of people in the US that are in debt. We needed an organized plan (and a change in our thinking) and Dave’s common sense helped us get on track.

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