Sunday, May 4, 2008

Financial Advisor Dave Ramsey's Debt Snowball Debt Reduction Plan

Financial Advisor Dave Ramsey's Debt Snowball Method for paying off debts

In the last few posts I have been writing about financial advisor Dave Ramsey and all of the incredible personal financial advising information he has to offer. Their are most certainly Dave Ramsey critics out there but for the most part everyone thinks that the information he offers is extremely helpful. The only complaints come from those that argue that his plan for financial freedom and financial peace is to conservative. I could agree with this if it was not for the debt epidemic among Americans. Unfortunately the criticisms from these critics does not take into account the fact that a lot of Americans do not have the discipline to pay off their credit cards in full every month or keep a handle on their debt.

Today I wanted to talk in detail about financial advisor Dave Ramsey's Debt Snowball reduction plan for paying off debts. This plan shows us excellent ways to get out of debt. The Debt Snowball reduction plan is the second step in financial advisor Dave Ramsey's 7 Baby Steps to Financial Peace training course and is probably the most important step in a persons quest for financial freedom and financial peace.

The ideology behind financial advisor Dave Ramsey's Debt Snowball reduction plan is to organize all of your debts and setup an easy, manageable, and results oriented plan for paying these debts off. These debts can include credit cards, car loans, student loans, payday loans, faxless payday loans or personal loans. It basically includes any debt that you have excluding your home mortgage.

The first step in the financial advising debt snowball debt reduction plan is to make a excel spreadsheet list of all of your debts with the lowest balance at the top of the list. He doesn't actually suggest personal debt consolidation but rather thinks you should pay off each debt ASAP starting with the smallest. After you make this list you then need to allocate as much of your monthly budget as you possibly can to debt elimination. After you have listed your debts in order from lowest to highest and decided how much you can put toward debt each month you need to determine what your payments for each account should be. This financial advising step is very simple. In the debt snowball debt reduction plan you pay only the minimum payment toward each debt you have except for the one at the top of the list (one with the lowest balance).

The plan is to pay off the smallest debt as quickly as possible and then once it is paid off you move on to the next smallest debt you have. When you move on to the second debt on your excel spreadsheet you then allocate the whole amount that was originally going to your smallest debt (the debt that is now paid off). These means that you will continue with the minimum you were paying on the now smallest debt and add the total amount that was going to your debt that is now paid off. After paying of the second smallest debt on your debt snowball excel spreadsheet you will move on to the third smallest.

The idea with the debt snowball reduction plan is to continue doing this until you have paid off all of your debts (excluding your house payment). Financial advisor Dave Ramsey's rational with the debt snowball method is to gain steam and see results by paying off the smallest debts first. The Debt Snowball method will help you to see real results and help motivate you to continue. For most people they need to see results and feel like they are making progress or they will quite within 6 months of starting a plan to pay off their debt.

Below I have included an example of the financial advisor Dave Ramsey debt snowball debt reduction plan for my readers. I have also included several links to Debt Snowball Calculators. The debt snowball calculator should help give you an idea of how long it will take to pay off each debt.

Example of the debt snowball method (Courtesy of Wikipedia)

Ignoring interest rates, let's pretend you have the following debt and minimum payments:

Car Payment - $2500 balance - $150/month minimum
Credit Card A - $250 balance - $25/month minimum
Loan - $5000 balance - $200/month minimum
Credit Card B - $500 balance - $26/month minimum

Your minimum payments for all debt would be $401 per month. You would order your debts in the following order (lowest to highest):

Credit Card A - $250 balance - $25/month minimum
Credit Card B - $500 balance - $26/month minimum
Car Payment - $2500 balance - $150/month minimum
Loan - $5000 balance - $200/month minimum

Now, assuming you had $100 extra per month to send in, you would apply that $100 to the Credit Card A so that the payment for it would be $125 per month and the other debt would receive the minimums.

After Credit Card A is paid off (in two months), you would apply the extra $100 to Credit Card B PLUS the $25 you were sending in to Credit Card A. So now your payment to Credit Card B would be: $26 normal minimum + $25 that you normally sent in to Credit Card A + $100 that you are able to send extra.

Your payment to Credit Card B would be $151 instead of $26. Therefore, you would pay it off much faster. Then, when Credit Card B is paid off, you would now send in the following to the Car Payment: $150 normal minimum + $25 that you normally sent in to Credit Card A + $26 that you normally sent in to Credit Card B + $100 that you are able to send extra. Your payment to Car Payment would now be $301 instead of $150.

To follow the debt snowball debt reduction plan you would simply continue to follow this plan until all debts were paid off.

Links to a download able and java script debt snowball calculator: (The java script one is more like a debt snowball calc and the other two would probably be considered debt snow ball calc software.)

Downloadable Excel Spreadsheet Debt Snowball Calculator

Java Script Debt Snowball Calculator

Mr. Peanut Debt Snowball Calculator

The debt snowball debt reduction plan is one of the best plans available for paying off debt. It helps people to see immediate results and gain momentum in their plan to be debt free. Go ahead and start your own debt snowball reduction plan and begin your journey toward financial freedom and financial peace.

Financial advisor Dave Ramsey is personal finance expert who specializes in giving out information to help people get out of debt and achieve financial peace. His radio show The Dave Ramsey Show is aired on over 300 different radio stations each day and heard by over 3 million listeners. Dave Ramsey is also the author of many great books including The Total Money Makeover, Financial Peace, and More Than Enough.

-Jesse

P.S. If your are looking for a personal financial advisor please email me and I will give you suggestions on which financial advising companies to consider.

4 comments:

JoeTaxpayer said...

The savings are greater and the debt will be paid faster by paying the highest interest rate card off first. One should pay in order of rate, not balance. The spreadsheets can easily calculate a monthly interest accruing and show how the payment made toward the highest rate debt can have twice the impact than towards the lowest.
Joe

Jesse said...

I agree with you Joe but I have explained why the debt snowball method is a good one. Your way will clearly save a little bit more money but often with your methods people will fail before they succeed and then not be any better off.

Most American's need to see results and see them fast or they will quit pretty quickly. This is why the paying off the smallest debts first is a good way to attack your debt.

StrongBad said...

The difference between the Snowball (smallest balance debt to largest) and Avalanche (highest rate debt first) methods is very little! As an example, with $305,000 in debt, I calculated I would only save $722 with the Avalanche method. Dave Ramsey often says that personal finance is "80% behavior and 20% head knowledge." The power of the Snowball is to get some quick wins and build momentum. Otherwise, most people will quit the plan before they pay off the first debt.

Auto said...

True, kinda. The idea of paying of the smallest first does make sense because you can eliminate them quicker. But if two are within close proximity, the higher APR should jump to the front of the line. Overall, some people need a good action plan, this is a good start for them.