Wednesday, November 19, 2008

Dave Ramsey's Baby Steps

As I said in an earlier post, I'm currently trying to follow Dave Ramsey's Baby Steps, as well as Crown Financial's Money Map. As you've probably figured out by the post title, I'd like to talk about Dave's Baby Steps today.

Dave Ramsey wrote an excellent book back in 2003 titled "The Total Money Makeover: A Proven Plan for Financial Fitness". In this book he outlines many sound financial principles and ideas (I highly recommend checking out a copy at your local library if you haven't read it). The key to these principles can be really summed up by his 7 Baby Steps. The gist of it, is that if you follow these steps you will gain financial freedom. So, without more ado, here are the steps:

1) $1,000 to start an Emergency Fund
Before you do anything you should have a small Emergency Fund so you don't have to fall back on going into debt when something unexpected happens. You'll notice I said when not if. :)

2) Pay off all Consumer debt using the Debt Snowball
In case you’re wondering what “consumer” debt is, that’s just debt outside of a mortgage. That would include credit card debt, auto loans, student loans, etc.

3) 3 to 6 months of expenses in savings

4) Invest 15% of household income into Roth IRAs and pre-tax retirement

5) College funding for children

6) Pay off home early
Dave also suggests that if you get a mortgage you get a fixed 15yr instead of a fixed 30yr so you build equity more quickly and pay less in interest over the life of the loan.

7) Build wealth and give!/Invest in mutual funds and real estate

We're trying to follow these steps right now and are on step number 2.

In case you're wondering what the Debt Snowball is, I think I can best describe it as a way to help motivate yourself into paying off debt. You start out by writing down all your debts. You then figure out how much money you have to put toward debt a month. After that you start putting whatever you can toward the smallest debt. Once you pay off the debt you roll the amount you were paying for that debt toward paying off the next smallest debt.

Let's say you have 3 credit cards. One has a balance of $4,000, the second has a balance of $500, and the third has a balance of $1000. Now let's say you have an extra $100 to put toward debt a month. Let's also say each of these credit cards has a minimum balance of $50 that you need to pay each month. So, you would start out by paying $150 per month on the $500 credit card until it was paid off. You would then roll over that $150 a month toward the $1000 credit card which would mean the payment on that is actually $200 a month ($150 + $50 monthly payment). After that's paid off you would do the same with the $4,000 credit card and would end up making payments of $250 a month on that. As you can see, the amount you put toward debt can quickly snowball into larger and larger payments.

Right now, my husband and I are on our last consumer debt. Once that’s paid off we’ll move on to step 3. I can’t wait!!



Actually, we are working on both steps 2 and 3, because we have a direct withdraw, putting money into an account.

Also curious, as I have not read the book, for step 3, is that a separate account than the "Emergency Fund"? Or is it saying that you should build your emergency fund up to a 3-6 month living fund?


@ Layneh

True True. We are working on both we're just working more actively on step 2.

Step 3 is just making that Emergency Fund larger so it will fund 3-6 months of living expenses.


Sounds like a good book. I like Dave Ramsey and Crown Financial because they don't encourage gimmicks. They promote fiscal responsibility and stewardship.

This snowball effect makes sense. Did he by chance compare it to paying off the one with the highest interest rate first? I think I have heard of that strategy also. Just curious to hear about the advantages and disadvantages of that.


@ Craig

You bring up a good point. There are actually several schools of thought on how people should pay off their debt. Dave thinks that you should pay it off smallest to largest debt with no regard for interest rates. I plan on doing a post, probably next week, describing other types of thought on this subject.

There is a big debate around it and I think both sides have valid points.


I can understand why he would focus on the size rather than the interest rate. If you focus on loan size, you can pay off and snowball faster.

When it comes to interest amount, you usually have more options to dropping that rate. The easiest way to drop the rate, that I have found, is to just call and ask them to lower it. We do that every 6 months, and havent been told no yet.

You can also go to a Bank or credit union and take a personal loan to pay off a credit card. Many times the lender will ask you to cut up the card though, which isnt a bad idea if your trying to pay off debt anyway.


Dave would tell you to cut up the credit cards anyway. That is whether you're getting a loan for them or not. there is simply no need to have a credit card.... period.

He would recommend you have a "plasectamy."

As for paying off the smallest debts first, the main reason is to get some momentum behind you. once you've paid off a debt, you start feeling more confident. That makes you want to pay off the next one even quicker. He calls that "gazelle intensity." You're running towards financial freedom like a gazelle runs from a predator.

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