Dave Ramsey’s Baby Steps says that you should pay up all your debt with debt “Snowball method”—which is debt payoff method where you arrange your consumer debt by balance, from the lowest remaining debt to the largest, then you prioritize the smallest debt first by making as much payment as possible on it while paying only the minimum required on other debts.
Baby Step 2: Pay Off All Of Your Debt (excluding house) With Debt Snowball
The most controversial of all his advice is that a debtor should ignore the interest rate on those debts, except two of those debts have similar payoffs, then you should prioritize the one with the higher interest rate. But numerous experts have disagreed with this method for the main reason that debts with high-interest rates are allowed to compound—which will result in the debtor paying a higher amount than necessary. As such, let’s consider other ways to tackle debt:
Ways to Tackle Debt
There are two main ways to tackle debt, they are the Debt avalanche method and the Debt Snowball. Although both methods are good, Dave Ramsey suggests that you should use the debt snowball method because it motivates you to pay-off larger debt. Let’s go into more intrinsic details so that you can fully understand debt payoff methods:
Snowball Method: As explained earlier, this method gives priority to debts that have the lowest debt balance—this way, you will pay the smallest debt first and sooner than you will pay others. If you need to be motivated, you can celebrate yourself after you’ve paid off the first debt.
However, it’s not everyone that needs to be motivated before they can clear their debt. Also, even debtors that require some motivation may still prefer a more financially prudent debt pay-off method.
Avalanche Method: This method believes that you should pay off your debts by ordering your debt from one with the highest interest rate, to the lowest interest rate, and putting every disposable income into debt with the highest interest.
Most financial advisors recommend this method because it helps debtors come out of their debt sooner than the Snowball method, and they’ll also pay the least amount of money—however, there is no data to support or antagonize this claim.
Savvy Method: The Savvy method is borne in the computing and data era, and because of that, this seems to be more beneficial to lenders. The Savvy method popularized by the Savvy Debt Payoff app makes use of the two methods.
If you don’t have the capacity to pay off your debt, then you should consider filing bankruptcy or debt settlement.
If you’re interested in any of these methods, then you should read up our guides on debt settlement, Chapter 13 and Chapter 7.
Steps After Becoming Debt-Free
Congratulations! You’ve now settled your debt, I’m certain that you felt that this day will never have come. But you scaled through by being resilient and making the right sacrifices. But you may be wondering about the next thing after settling your debt. Here are some basics things to do now:
- Stop Using Your Credit Cards
If the debt you settled was your credit card debt, then you have to halt all transactions on the credit card. There is a tendency to start racking up debts again after paying your debt, it’s a dangerous cycle you need to avoid falling into. If your debt struggle was due to high credit card debt, then you need to avoid using your credit card for a certain period.
- Revisit your budget
Always revisit your budget every three months to ensure that you’re still aiming at your goal. But this is a particularly important step if you’ve just made a significant financial change.
- Allocate more money to your goals
Since you’ve now settled your debt, you need to redirect funds that are previously used for debt payments to funding things that can help you reach your goal. For example, if you want to start a business, you should start saving up to start your business.
What Kind of Debts Are Okay
Contrary to the popular opinion that all debts are bad, there are actually some good debts that can benefit you financially. Any debt that will result in a long-term beneficial outcome is good debt. Here are some examples of good debt:
Business loans: It is a wise investment to get a loan to start or expand a business—provided that a well-detailed feasibility study of that business was done.
Home mortgages: Home values rise and fall in the short term, but when in the long-term, prices are guaranteed to rise. According, to Zillow, the medium price for buying a house in the U.S. is $199,200, while the medium home value in 1940 was just $2,938.
Student loans: Although there is no guarantee that you will get a job after getting a college degree, however, numerous research has shown that it can significantly contribute raise your income. To ensure that your good debt works for you, make sure your debt-to-income ratio is kept under control, and avoid taking debt that will result in the need to file for bankruptcy, debt settlement, or any other debt relief method.
Summary
Dave Ramsey’s baby steps can be beneficial if you need to be motivated to pay your debt. However, it’s not the most financially prudent way to settle a debt as you’ll be paying more than you should if you had tried the Avalanche method of paying your debt.