This is the second installment in our Get Out Of Debt series.
In step one of Dave Ramsey’s debt removal plan, he had you save up $1000 for unexpected emergencies. Now we come to the heart of the 7 step process, paying off the debts. No investing, no building up your saving accounts. That comes later. Before you can successfully begin to build wealth, you must first stop hemorrhaging money with huge debts. If a man walks up to you with a gaping chest wound, do you first stop the bleeding or patch up his clothes so that he looks nice? Stop the bleeding! Building wealth on top of debt is like building a mansion on top of a leaking dam. If you want your house to survive, you must first fix the dam. So, 3 metaphors later, have I convinced you to stop building wealth and investing prior to paying off your debt? Listen to what Dave has to say about this.
“The most powerful wealth-building tool is your INCOME. Ideas, strategies, goals, vision, focus, and creative thinking all have their place, but it is when you get full control and use of your income that you build wealth – and not only build it, but keep it. A very small percentage of people may inherit money or win a jackpot, but these two avenues to wealth are the result of dumb luck. They are not a proven plan to financial fitness. To build wealth, you have to CONTROL your income.
The bottom line for becoming wealthy is this: Don’t have any payments. Debt is the enemy of your income. It keeps you from becoming wealthy. It keeps you from enjoying the feelings of security and flexibility associated with wealth. One of the reasons I am so passionate about a person’s getting rid of debt is because I’ve seen thousands of individuals make HUGE strides toward becoming millionaires in a relatively short time AFTER they get rid of their ‘payments.’ Just think how much you could do with your income if you did NOT have a car payment, student load, credit-card balance, medical debt, or even a mortgage.” ~Dave Ramsey – The Total Money Makeover Workbook pg.145
So, how does one go about paying off debt? Dave recommends the snowball technique.
List all of your debts excluding the house payment. We’ll take care of that later.
Seriously, go get a sheet of paper and do it now. I’ll wait. Write down the name of the debt, the balance, and the minimum payment. List them all, everything from your student loan to your clothing store credit cards. Now, sort them from smallest balance to largest balance. This is the order that we you will pay them off. Interest rates don’t matter unless you have two debts that have similar payoffs. In this case, pay the higher interest one first.
Now to get started, payoff the smallest one. Pay the minimum to your other debts, and focus all your attention on the smallest one until it’s done and gone. Now take the minimum from that smallest one, and apply that and the minimum from your second highest until it’s gone. Repeat this process until you are out of debt. It’ll make more sense in a chart.
Once you paid off your Penny’s card, you took the minimum payment of $15 and added it to your Sears minimum of $10 to get a new payment of $25. Upon paying off your sears debt, you add that $25 to the minimum of $75 from your visa debt and begin paying $100. Doing this, along with applying any extra money toward this debt creates a snowball effect. With each debt you pay off, you have more income with which to pay off the next one. Using this method, the debt above could be paid off in 26 months.
In my own experience we had a larger debt than the example, and we paid it off faster because in addition to the snowball, we applied everything we had into paying it off. No new clothes, no Starbucks, no eating out, no movies. We lived cheaply for a year and reduced our debt to only a house in less than two years. I highly recommend this method because it works both mathematically and emotionally. If you look at the debt snowball only in terms of mathematics, there are other ways that claim higher efficiency, but they miss the psychological component of the debt snowball. This method allows you to make early ‘wins’ in the debt payoff race and it feels good. Every debt that falls by the wayside releases a burden and really causes you to refocus and stay the course.
So, step two the getting out of debt is to pay off your debt. It really is that simple. No magic, no get rich quick scheme. Just use your income and your head. Stop hemorrhaging money and start paying off your debt. For more details on the debt snowball method, check out Dave’s book. I think every man who isn’t already independently wealthy should read his book and apply its principles to his life. You can be a gentleman regardless of your means, but it’s more fun to be a gentleman of means.