Now that you have $1,000 cash saved up for your starter emergency fund, you’re ready for Baby Step 2. This step will most likely take longer than the previous step, but oh does it feel so good to destroy your debt. In this series we’ll focus on what The Debt Snowball is and how to make it work for you! Let’s review the 7 Baby Steps:
Dave Ramsey’s 7 Baby Steps
- Step 1: Save up $1,000 to start your emergency fund.
- Step 2: Pay off all non-mortgage debt using the debt snowball.
- Step 3: Save up 3 to 6 months of expenses to complete your emergency fund.
- Step 4: Invest 15% of household income into Roth IRAs and pre-tax retirement accounts.
- Step 5: Work on college funding for children.
- Step 6: Pay off your mortgage early.
- Step 7: Build wealth and give!
Why pay off debt?
Dave makes the point that it is easy to become wealthy as long as you have no payments. Payments are what keeps us down from using our income to build wealth. Many people make huge strides toward becoming millionaires once they get rid of their debt.
Try this: Get out a calculator and add up all of your monthly credit card, vehicle, student loans and other payments (except for your mortgage). Now imagine that you had that extra money to spend each month. Wouldn’t that be wonderful? Well, you can have that extra money, but to do so you’re going to have to get rid of your payments.
It is sometimes hard to believe that we can live without debt. After all, debt is one of the most fiercely marketed products on this planet. But you CAN live without debt and doing so will set you free. Let’s get this ball rolling with The Debt Snowball.
The idea behind The Debt Snowball is that you can build momentum as you pay off your debts. The ball starts at the top and rolls down the hill, picking up more snow as it goes. In a similar way, you can pay off your debts. To do this, follow these simple instructions:
- Make a list of all your debts starting with lowest balance moving to largest balance. Interest rates don’t matter. See below for an explanation.
- Make minimum payments on all debts except for the debt at the top of the list.
- Scrape together as much money as possible to pay off the lowest balance debt.
- Once you’ve paid off the lowest balance debt, take the extra you have from not making payments on the first debt and use it to pay off the second debt on the list.
- Repeat. Repeat. Repeat.
Some people make the argument that paying off the highest interest rate first will save you money. They’re right, but the problem is that this might push a higher balance to the top of your list – something that might discourage you from knocking out your first debt. By paying off the lowest balance first, you’ll feel exhilaration pushing you forward. You’ll see progress quickly and be encouraged to continue.
While making your list, you might find that two balances are nearly equal, but one debt has much higher interest than the other. In this case, it is okay to pay off the higher interest rate first, but this is the only exception. Remember, paying off your debts is about 80% behavior and 20% head knowledge.
But I have no wiggle room! How can I pay off my debts?
It can be difficult to pay off debts when you are living paycheck to paycheck. When you are just getting started on this plan, you should have created a budget. Often, creating a budget will show you where you might be overspending. The budgeting process can save you hundreds if not thousands of dollars each month. Use this newfound money towards your debt snowball.
If you still don’t have room in your budget, you might have an income problem. Here are some tips on improving your long-term income. Meanwhile, try the following:
- Sell lots of stuff! For example, sell vehicles that you can’t afford. Dave’s rule for vehicles with motors (cars, trucks, motorcycles, boats, etc.) is that the total value doesn’t exceed half of your annual income. Also, try eBay!
- Get a temporary job. While you’re seeking after your long-term career, land a few side jobs to help obliterate your debt. This will help get your snowball rolling with more intensity.
- Use gifted money towards your debt snowball. Yeah, sometimes you have to sacrifice to win. Take that extra birthday money you got from Aunt so-and-so and drown your debt!
Get gazelle intense!
Dave tells a great story about how the gazelle escapes the cheetah. The gazelle RUNS. FAST! You’re going to have to weave back and forth to outsmart the enemy: debt. Getting gazelle intense for a short period of time allows you to live well later in life. But not much later! Success is closer than you may think.
Moving through the debt snowball might take a couple of years. But it is WORTH EVERY SECOND. You’re going to have to sacrifice some luxuries to get ahead. Remember the vision: no payments. You can do it.
After you’re done eliminating all your debt besides your mortgage (if you have one), you’re ready for Baby Step 3. Remember that beginner emergency fund? It’s time to build it up!
Previous In Series: Dave Ramsey’s 7 Baby Steps: Step 1 – Save Up $1,000 to Start Your Emergency Fund