In a previous post, we reviewed Step One of Dave Ramsey’s seven-step guide for reducing debt and building wealth in his book, “The Total Money Makeover“. As we will be covering each of these “baby steps,” as Ramsey calls them, in individual postings, let’s look at the next one.
How The Snowball Method Works. Once you establish an emergency savings account (per baby step one in Dave Ramsey’s book), you are ready to come face-to-face with your debt situation by using the snowball method to pay off your debt. In my opinion, this is the hardest of all of the baby steps.
If you are not familiar with the snowball method, it is a financial method in which your debt is paid down by –
- Organizing debts from the lowest balance to the highest monthly expense;
- Allocating that specific amount be paid toward each debt monthly;
- Paying the minimum amount on all the debts, except the debt with the lowest balance;
- Putting the remainder of all your money left over from paying your bills (lights, mortgage, etc.) that you calculated in your budget towards the debt with the lowest balance; and
- Continuing the process after the first debt is paid, then moving all of that money towards paying off the next highest debt. So, now you are paying all your disposable income, plus the old payment, plus debt #2’s normal minimum payment, and then constantly repeating the process by piling old minimums onto
Bottom Line Up Front. Clear as mud, right? The debt snow ball is simple even though it is hard to quantify into words. You pay your smallest debt off with all your disposable income that you have left over from paying all your bills (based on your monthly budget). Then, you move on to the next one with ALL your money. And, then the next….and the next…and the next until it is all gone.
Why the Snowball Method is Better. The approach that Ramsey suggests is a good way to pay off debt, especially for anyone who does not follow a disciplined approach toward spending or saving. Contrary to Ramsey’s suggested method, most debt specialists will advise you pay down your debt with the highest interest rate, but Dave Ramsey does not recommend this based on emotion. There is a certain amount of satisfaction associated with paying off one of your debts whether it is a Visa card, HELOC, car payment, or some other debt. Ramsey’s debt snowball builds on that enthusiasm. You get fired up, and that keeps you going.
You can become quite frustrated with this method though if the debt with the highest amount of interest is somewhat substantial. By using Ramsey’s method, you can get rid of your debt faster so you can proceed on to the next steps of completing and funding your emergency savings account, investing for retirement, saving for your children’s college, paying off your house payment, and finally realizing the goal of building real wealth. With Ramsey’s book, The Total Money Makeover, you can learn how to get rid of the negative impact that debt can have on your life. Therefore, the snowball method is the best way to eliminate debt so you can learn to save.
A Review of the Basic Steps for Saving, Eliminating Debt, and Building Wealth
Ramsey’s program and book, “The Total Money Makeover“, include the following baby steps to financial freedom…
- Step One: Save $1,000 for an emergency fund
- Step Two: Use the debt snowball method to pay off your debt
- Step Three: Complete the emergency fund
- Step Four: Invest 15% for retirement
- Step Five: Save for your Children’s college
- Step Six: Pay off your mortgage
- Step Seven: Start building wealth
For the next seven days, I will be detailing each one of these baby steps in more details. So, please check back or sign up to get all of the posts in this series in your favorite RSS Reader or by E-Mail.