Now we are back on track. Dave Ramsey’s first class of FPU discussed the importance of having an emergency savings of $1000, what he calls Baby Step 1. Before moving onto Baby Step 2, he takes a detour to talking about Relationships and Money and then Budgeting to build a foundation. Now he turns back to his Baby Steps.
Baby Step 2: The Debt Snowball
Ramsey’s Debt Snowball has received some criticism because it is not the fastest way to get out of debt. A foundational principle that Ramsey holds to is that behavior, rather than know-how, is the biggest part of handling personal finances. This is why the Debt Snowball is set up the way it is. Here’s how it works:
- You compile a list of all your debts – from car loans to student loans to friends to credit cards
- Put them in order from lowest balance first, to highest balance last
- Funnel every extra dollar you have to the debt at the top of the list (the smallest one in terms of amount) while making all the minimum payments on all the others
- When you pay off and eliminate that first one, you work on the next, again funneling all money, including what you used to spend on the first debt, towards the next largest debt
- As you pay them off one by one, the debt elimination accelerates, much like a snowball growing as it rolls down a hill
That second point is where Ramsey catches some flack – by ordering them by balance, rather than by interest rate, you’re actually not paying them off as fast as you could. Ramsey does say elsewhere that if two balances are about the same, you would want to pay off the higher interest rate first. Ramsey is not concerned with efficiency here, but rather success. He knows that emotions play a large role in this – the better you feel about your situation, the more likely you are to keep going with the debt snowball. You need momentum. Most people’s smallest debt is under $1000. If you can pay that off quickly, you feel like its working and get excited to pay off the next one. By the time you’re ready to tackle the biggest debts, you have motivation, momentum, and confidence, as well as extra cash flow.
Ramsey pulls imagery from Proverbs 6:1-5 to communicate the way out of debt – you have to run from debt like a gazelle running from a cheetah. You work at getting out of debt like your life depends on it. This includes finding a part-time job, working extra hours, selling things you don’t use, and doing everything you can to save money and pay off debt. He’s that serious. Again, you have to give yourself some momentum, or you’ll slip back into your old patterns.
In this class session, Ramsey spends almost the entire time “Debunking Myths” about credit and debt. Sometimes he makes valid points, but many of his “truths” about debt don’t directly respond to the “myth” that he is debunking. For example, he cites the following myth and truth:
- MYTH: “I’ll make sure my teenager gets a credit card so he/she can learn to be responsible with money.”
- TRUTH: “Teens are a huge target of credit card companies today.”
The truth given, while it is true, doesn’t really answer the myth. Shouldn’t a teenager learn how to be a target to marketers without giving in to buying everything they see? A credit card with a small credit limit can help them do that, can’t it? It seems like Ramsey is more concerned with addressing common practices than truly correcting myths about credit and debt.
A Little Sloppy
In the process of debunking myths, Ramsey throws out a lot of statistics, such as referencing a Forbes 400 survey where 75% say that getting and staying out of debt is the key to building wealth. From reading his book, Complete Guide to Money, that came with the class materials, I know that Ramsey can get a little sloppy with statistics and facts. For example, in the “Dumping Debt” chapter of the book, Ramsey says that “the average cardholder has more than 7 cards.” This seemed high, so I checked his reference and looked up the report he’s pulling from. It turns out he just divided the total number of cards out there (which includes business cards and canceled cards) by the total number of cardholders. According to Gallup, only 8% of Americans have 7 or more cards and the average is 3.7 cards per person. Postconsumers.com says the average is 3.5 per person. So when he says that 75% of the Forbes 400 are against debt, I’m skeptical. I scoured the internet for the source of this survey, but could only find either instances of Ramsey repeating the statistic or other people citing him. In addition, the stat is only mentioned online. Its not in his book, where there would be higher standards of statistical integrity. If anyone could find the original source for this, I would really appreciate it.
The Final Word
In conclusion, I think Ramsey’s method for getting people out of debt is both clever and effective. He is smart to put stock (no pun intended) in people’s behavior and leverage that to help motivate their debt reduction. However, it seems that he is so convinced and so passionate about being debt free, that he goes overboard in trying to convince people to agree with him. In a way, it almost makes him less credible. Personally, I’m still trying to figure out whether one should pursue debt reduction in the first place, especially as aggressively as Ramsey calls for.