Before you actually start the Dave Ramsey’s plan you have to declare war on debt. No more debt! PERIOD! Stop using credit cards, don’t borrow cash from your brother…no credit of any kind. If you don’t have the cash to pay for it, don’t buy it. You need a true commitment to getting out of debt and becoming financially responsible.
Emergencies seem to happen to us when we are least prepared for them. Just when we think the monthly budget looks balanced, the car breaks down or a child gets sick. That is when we want to throw in the towel and say “forget it”. It’s like eating the whole gallon of ice cream with the piece of cake when you have stuck to your diet all day. Emergencies and unplanned expenses leave us feeling hopeless. Dave Ramsey’s solution to this is an emergency fund.
Baby Step #1 sets saving as a priority. Expect that unexpected events are going to happen. Things that you can’t foresee but “God Only Knows” may happen.
Don’t think this is the entire emergency fund that you will ever need. This is just to hold you over while to move onto Step #2. There will be a larger more permanent emergency fund established in Step #3.
So, how do you build your emergency fund?
• Make only the minimum payments on your debt until the emergency fund has been established.
• Cut your budget (no eating out or extras services)
• Sell unwanted items around the house using eBay, consignment shops or the like
This step may take you a few months depending on how much you are able to scrape up.
An emergency fund gives you a sense of security, a safety net, so that you can concentrate on other more important things and you are less likely knocked off course.
Once you have your baby emergency fund in place now you start to tackle your debt. What Dave Ramsey suggests is to make a list of all your debt (except for the house) from smallest to largest. Make only the minimum payments on all of them except for the smallest which you attack with a vengeance getting rid of this one as fast as you can. Once you have gotten rid of that one, take the amount you were paying on that debt and apply it to the #2 along with the #2 minimum payment and so on. Each time you finished off a debt the payment applied to the next would get bigger and bigger hence the “snow ball” effect. You will target one debt at a time and compound your payment.
Here is an example…
• Store Credit Card $ 625 balance $ 25 minimum payment
• MasterCard $ 640 balance $ 35 minimum payment
• Medical Bill $1,225 balance $ 50 minimum payment
• Discover $3,250 balance $ 75 minimum payment
• Visa $7,250 balance $100 minimum payment
• Student Loan $8,600 balance $150 minimum payment
Lets say you are able to squeeze out another $100 per month to pay down your debt, this means you will be making a payment of $125 on your Store Credit Card taking you a total of 5 months to pay it off. You would then take the $125 and add it to the MasterCard’s minimum payment for a total of $160 per month and in about another 4 months this one would be paid off. You would then take the $160 per month and add it to the Medical Bill’s minimum payment for a total of $210 and so on. Each time you paid off a bill the amount you applied to the next would get larger until all of them were paid off.
There are some analysts that say you should pay off the debt with the highest interest rate first, which in theory would be the best money saving way, however; Dave Ramsey’s using a more psychological approach. By knocking off the small debts you get quick results and this helps you gain the momentum to continue. You are able to see progress much faster and therefore stay on track longer.
Through baby step #2, you continue to squeeze every dollar you can out of your budget to throw toward your debt. Dave even suggests getting a second or third job if you can. Your budget should be so tight that you are not doing anything that is recreational. He often says… “you don’t see the inside of a restaurant unless you work there”.
Once you have completed Dave Ramsey’s Baby Step #2 you are no longer normal. Normal people are broke and have debt! You have made great strides to financial freedom and you are ready to move on to making your money work for you.
Dave Ramsey’s Baby Step #3 is a Fully Funded Emergency Fund of 3-6 months of expenses. Think of this as a type of self-insurance. The $1,000 emergency fund was great when the car needed repair or the baby got sick. Now, you need to protect yourself from a loss of a job or major illness. This is not an investment so keep your emergency fund in a money market account or some type of savings account easily accessible. I know it’s not going to make money, but don’t look at it as an investment, think of it as insurance, a cushion sort of speak.
By this time you have paid off your debt except for the house and you have a fully funded emergency fund with 3-6 months of expenses in the unfortunate event that something catastrophic happened. Now it is time to start planning for the future and putting 15% of your household income into a pre-tax retirement account such as a company 401k or IRA.
Dave Ramsey has a really neat calculator here here
that lets you figure out how much you need to invest and what the value of it will be when you retire. Play around with the numbers and you will be amazed on how compounding interest is going to be your friend!
It’s taken you a long time to get here but boy has it been worth it. You are out of debt, have some money in the bank and you have made arrangements to not work your entire life. Now let’s focus on the kids. If a student loan debt was in your Baby Step #2, then this step should be a no brain-er for you. Imagine your children embarking on adulthood with no debt. We all want our children to have the best education and financial footings possible and this step does both. Dave Ramsey suggests that you start putting money in a savings account such as a 529 Plan for your children’s educational expenses. Stay clear of insurance policies, bonds, and prepaid tuition plans.
Even though you can claim that you are debt free after Baby Step #2 according to Dave Ramsey’s plan, you are not officially debt free until you have NO debt. So, now is the time to get rid of it all. Baby Step #6 is to throw all extra money toward paying off the house.
Dave Ramsey suggests getting no more than a 15 year fixed rate mortgage that is no more than ¼ of your income. If you don’t already have a 15 year fixed rate mortgage, now is a great time to refinance at a lower interest rate and knock off some years to boot. Moving from a 20 or 30 year mortgage to a 15 may mean that your payments are going to be higher but you will pay off the house faster and besides, you don’t have any other debt at this point so all your extra money should be thrown to pay off the mortgage anyway.
Some of the major reasons to pay off your home early included…
• Save thousands of dollars on interest payments
• Less stress
• Peace of mind
• Freedom to use that money to build wealth
Once you have paid off your mortgage, you will have an enormous peace of mind knowing that your house is paid for!
You have reached financial peace. Now your job is to keep the balance. Having an abundance of money is not going to solve all of your problems. Dave Ramsey’s Baby Step #7 helps you build wealth and give.
In this step you will…
• Live like “No One Else” and have a little fun
• Invest so that you money starts working to making you more money
• Give money away
Since you have lived the life of frugality through Baby Steps #1-#6 now its time to have a little fun and buy the items that you have been putting off since you deserve it! Lets also make your money start working for you. Dave Ramsey suggests that you invest in good growth stock mutual funds and possibly yield a 12% return.
Start giving like you’ve never gave before. Find needs in your community and financially support them or pay a neighbor’s electric bill.
What am I going to do at Baby Step #7….help someone else go through the Dave Ramsey’s baby steps.