Dave Ramsey's 7 Baby Steps for Getting out of Debt
Trying to shovel your way out of a mountain of debt? Popular financial expert Dave Ramsey, the host of the nationally-syndicated radio program The Dave Ramsey Show, suggests that you follow these seven "baby steps" as you pay off debt and build wealth.
Contribute $1,000 to an Emergency Fund
An emergency fund, also known as a "rainy day fund," is money that you set aside in case of a dire emergency. It's NOT an account that you tap to go on vacation or buy a new vacuum cleaner. Even if you have massive credit card debt, Ramsey says you should put aside $1,000 in an emergency fund. Then start focusing on your debt.
Why? Think about it - if you incur a large expense thanks to an emergency, like a trip to the ER or your car dying, that cost could send you straight back into debt. Having $1,000 saved up to help you means less of a chance of racking up more debt.
Pay Off Your Debt
Step two is a big step, one that might take years: pay off all debt except for your mortgage. Ramsey advocates a tactic called the "debt snowball." This involves paying debts from the smallest balance to the largest balance, regardless of interest rate. This is a controversial tactic. Most finance experts advocate "debt stacking," where you focus on paying off the debt with the highest interest rate first.
However, many people have had success with the debt snowball because this method gives people momentum with their debt payoff. By getting rid of your smallest debt, you feel a sense of accomplishment that can carry through to your next smallest debt.
Build a 3-6 Month Emergency Fund
Once all your debt is paid off, build an emergency fund that covers 3-6 months of your living expenses. This will save you from going into debt again even more in the event you face a major crisis, like a job loss. If that seems like a lot, remember that you'll be debt free at this point, so all the money you were using to pay off your debt can now be directed toward your savings.
Save 15 Percent of Your Income for Retirement
The next step is to put aside 15 percent of your total household income into retirement accounts such as a Roth IRA or traditional 401k. Don't worry if your employer doesn't offer a retirement plan. You can set up your own individual retirement account, or IRA.
If you want to save more, you can - Ramsey just recommends starting with 15 percent. Increasing that to 30 or even 50 percent will get you on track for early retirement (depending on your age), which is a goal for some people.
Save for College
Next, start saving for either your own college education or your children's college education (or both!). He recommends using 529 College Savings Plans and Educational Savings Accounts (ESAs) as your savings vehicles. Think this should come before saving for retirement? Look at it this way: your children can take out loans for college. You can't take out loans for retirement. Put your future first.
Pay Off the Mortgage
Now it's time to throw every dime into paying off your mortgage early. Why wait 30 years to finish making house payments? You can aggressively pay down the principal and become completely debt-free, including your home!
This can be a great move for retirement, especially if you plan on living in your current home for the rest of your life. You'll have the peace of mind that comes with knowing you own your home free and clear. No one wants to worry about making their mortgage payment in retirement.
Build Wealth and Give
Now you're saving 15 percent towards retirement (or more), you're debt-free (including the mortgage), and you're prepared to send your kids to college. It's time to focus on building wealth by investing, creating businesses, etc. Don't forget to give to charity now that you're taken care of, either. The best thing about having wealth is sharing it with others who need it more.