To Debt Snowball or Debt Avalanche, That Is The Question.

Which Debt Reduction Method is the Best?

I’ve been reading a lot lately about how one method or the other is best for getting out of debt. There are a ton of programs being touted as “the best”, and I do think some probably work better than others. So what do I think is the best? Here’s a quick look at a couple of the good ones I’ve seen.

The Debt Snowball

The debt snowball method, taught by Dave Ramsey, is one of the more popular debt reduction tactics being used right now. To do the debt snowball, you follow this progression:

Put all your debts in order from the smallest balance to the largest.
Pay the minimums on all of your debts.
Put any extra money towards paying off the smallest debt first.
Once the smallest debt is paid off you roll that money over towards paying off the next largest debt.
Wash, rinse, repeat.

The method is touted as being successful because it gives you some “quick wins” and motivates you to keep paying down your debt. To hear why Dave Ramsey thinks the plan is successful, listen to the audio on this post.

This method is criticized because it isn’t mathematically the soundest way to pay off debt. You will probably end up paying a bit more using this plan than some others. Proponents counter this by saying that the psychological boost you get from this method easily outweigh the small amount of interest you might save.

The Debt Avalanche

Another popular debt reduction method is the debt avalanche as popularized by Consumerism Commentary. Using the debt avalanche works like this:

Order your debts in order from the highest interest to the lowest interest.
Pay the minimums on all the debts.
Put any extra money towards paying off your highest interest debt.
Once the highest interest debt is paid off you roll that money over to paying off the next highest interest debt.
Wash, rinse, repeat.

This method is touted as being the mathematically best way to get out of debt. You’ll pay the least amount of interest, and be able to start saving for your future in no time.

This method is criticized because critics believe it doesn’t take into account the human element of debt reduction. It requires you to be more disciplined, and be able to follow through with payments even when you don’t see immediate results.

So Which Is Best?

So which method do I think is best for getting out of debt? Whichever one you choose to do! I think personal finance is personal so one person might connect more with one plan, and another with the other. More analytical types might work better with the debt avalanche, and more emotional free spirits may connect better with the debt snowball.

I think as long as you’re making a plan to get out of debt, you are headed down the right path. As Dave Ramsey says:

You can’t go wrong getting out of debt!

You can’t go wrong getting out of debt, no matter what plan you choose. The key is to GET OUT OF DEBT!

Here’s a roundup of what other people are saying:

Do you think there is a best way to get out of debt? What method have you used to reduce or get rid of debt?

For fast, effective, financial relief: You Need A Budget

August 29, 2008 · Filed Under Commentary, Dave Ramsey, debt, debt snowball

17 Comments

Dave Ramsey explains why the “Debt Snowball” works

photo credit: SqueakyMarmot

I’ve heard a lot of discussion about Dave Ramsey’s Debt Snowball recently, and why his method is mathematically inferior to other methods of reducing debt. Ramsey says he realizes that sometimes his way isn’t the best mathematical way to get out of debt, but that it still IS, in his opinion, the best way to get out of debt. Below is a quick explanation from his radio show on July 7th about why the Debt Snowball works.

I know this doesn’t do anything to end the debate, but it does help to explain Ramsey’s thinking behind the debt snowball. And you have to admit, his methods HAVE worked for a lot of people.

July 17, 2008 · Filed Under Credit, Dave Ramsey, Post With Audio, debt snowball

7 Comments

Dave Ramsey’s Financial Peace University: Week 7 - Clause and Effect: Buying Insurance

Last week - Buyer Beware

Last week was our 6th week in Dave Ramsey’s “Financial Peace University“. Week 6 talked about being an informed consumer, and not falling prey to the tactics retailers use to get you to buy. Some important points:

Learn the marketing method companies use to market products and services to you. Know you can be in control!
Wait 24 hours before making a major purchase - larger than $200.
Always talk to your spouse before making a major purchase.

The main thing that I got out of week 6 was that we are all very susceptible to marketing techniques companies are throwing our way - whether we admit to it or not. We need to be aware of when we’re being sold a bill of goods, and be able to tell the difference between a good deal from a good salesman.

This week - Clause and effect!

This week we talked about insurance, and what kind of insurance you need to buy. Key points:

Make insurance coverage a priority to avoid a financial disaster.
Learn the types of insurance you really need and get them NOW!

What kind of insurance do I need?

This lesson talked about why you need insurance, and what types of coverage you need to buy when you’re looking for your policies. So, what types of insurance can you buy?

life insurance
health insurance
homeowner’s insurance
auto insurance
disability insurance
long term care insurance

Dave Ramsey suggests buying insurance in all of these categories, but depending upon your situation your level and types of coverage may vary.

Life Insurance

This is one area that Dave Ramsey says a lot of people get hoodwinked. There are two main types of life insurance policies, term life and whole life/cash value. From Dave Ramsey’s website:

Sadly, over 70% of the life insurance policies sold today are cash value policies. A cash value policy is an insurance product that packages insurance and savings together. Do not invest money in life insurance; the returns are HORRIBLE. Your insurance person will show you wonderful projections, but none of these policies perform as projected.

According to Ramsey there is almost no situation where you would ever want to buy whole life or universal life insurance. Term insurance is almost always cheaper, and you can invest the difference of what you would have paid to whole life insurance. When you invest the difference on your own you’ll be able to get much higher returns - and you won’t be paying all the miscellaneous fees to the life insurance company.

According to Consumer Federation of America, Kiplinger’s Personal Finance, and Fortune magazines the return for a whole life policy will average 2.6% per year, 4.2% for universal life, and 7.4% for the new-and-improved variable life policy that includes mutual funds. The same mutual funds outside of the policy average 12%. Obviously you can do better investing outside of your life insurance.

The other catch about whole life insurance is that if you do die, your family doesn’t get the cash value back that you invested in the policy. They will only get back the face value of the policy. Any savings you have accrued are surrendered to the company!

So, to review - BUY TERM INSURANCE ONLY.

photo credit: Laineys Repertoire

Health Insurance

Health insurance is something that everyone needs to buy. If you don’t believe me, just look at the stats. Medical bills are the number one cause of bankruptcy! My wife and I have personal experience in this area. My wife had a life threatening blood clot in her leg this year, and was forced to undergo multiple procedures and several weeks of hospitalization, much of it in intensive care. Without insurance we most likely would have been faced with hundreds of thousands of dollars in medical bills. We probably would have been forced to declare bankruptcy.

Fortunately we had good insurance coverage and we were able to top out our medical expenses at around $2000. That’s quite a difference from $200,000. We were able to pay our medical expenses out of pocket with cash from our emergency fund. (By the way, when paying your medical bills, don’t forget to ask for a reduction in your bill because you’re paying cash).

Dave suggests that people look into Health Savings Accounts (HSAs) as a lower cost option to insure your family. If your company offers a health plan, look into that as well, usually plans offered through your company will be cheaper than if you bought it on your own.

Homeowner’s and Auto Insurance

Some points to remember when buying Homeowner’s and Auto Insurance:

Raise your deductible to lower the rates (only if you have an adequate emergency fund)
Carry adequate liability coverage
Consider dropping collision coverage on older cars
Homeowner’s insurance should carry guaranteed replacement cost
Once you have some assets, an umbrella policy might be a good buy to avoid a financial catastrophe

Disability Insurance

Disability Insurance is designed to replace income that is lost due to a short-term or permanent disability. Dave Ramsey suggests getting this type of insurance. If your workplace offers disability as a part of your employment, even at a reduced rate - you may want to consider it. Things to think about when buying your plan:

Consider a longer elimination period for your policy (the time it takes for the payments to kick in from your disabling event). If you have an emergency fund, you can have a longer elimination period, and pay less for the insurance.
Buy it for 65% of your current income, and buy the policy with after tax dollars.

Long-Term Care Insurance

This is a good idea if your 60 or older. Any younger and you probably don’t even need to consider it just yet. After 60, it’s important because almost 7 out of 10 people over the age of 65 will require long term care at some point in their lives.

Next week

Next week is a lesson entitled “That’s Not Good Enough!” which talks about how to find a deal, and negotiate when you’re buying.

Guarantee Trust Life Insurance Company No medical exam life insurance. Get up to $250,000 in affordable term life insurance online fast and easy. GTLDirect offers a 10 day money back guarantee for your satisfaction.

July 9, 2008 · Filed Under Commentary, Dave Ramsey, Financial Peace University, Insurance, debt snowball

8 Comments

Dave Ramsey’s Financial Peace University: Week 6 - Buyer Beware

Last week - credit sharks in suits

Last week was week 5 in Dave Ramsey’s “Financial Peace University“. The lesson for week 5 was focused on credit sharks, and the tactics they use to make you and your family go hungry. Some of the lessons we learned:

If you are unable to pay the minimum payments, use the Pro-Rata plan.
Always budget for your necessities before paying off any debt.
Check your credit report for errors every two years.

What was really stressed in this lesson was that you really do need to pay your debt, but never pay your debt before taking care of your own essentials including food, clothing, shelter and transportation. The debt collection companies have to work within certain federal guidelines, and you can work with them, within that framework.

This week - Buyer Beware!

This week we talked about common traps to avoid when buying things. Some of the important points from the lesson:

Learn the marketing method companies use to market products and services to you. Know you can be in control!
Wait 24 hours before making a major purchase - larger than $200.
Always talk to your spouse before making a major purchase.

Know how they’re selling to you so you have the power

Dave Ramsey talks about how when you’re purchasing something that they almost always will use the same or similar tactics to get you to buy. You need to know how the companies are selling to you in order to overcome their tactics, and make a smarter purchase.

For example, one tactic a lot of companies nowadays are using is the 0% financing offer. They lure you in to buy a car, a couch or that beautiful new 60″ TV by offering you a 0% financing deal on the purchase of that product. What they don’t tell you (except for in the fine print) is that if you don’t pay the balance of that loan by the time the initial term is over, your finance rates will shoot up to 20-30% , and you’ll often be liable for the finance charges for the 0% term as well. Or if that isn’t the case, and your 0% financing is legit, you’ll often find that the price of the item you’ve purchased has been increased before you bought to cover the cost of financing it.

Another thing that many companies will do is use a distraction technique. They’ll tell you about all the things the product will do for you, how wonderful it is, and how your life will be better because of it. Meanwhile they’ll avoid talking about the price unless it is in terms of how you can’t afford not to make the deal. One Dave Ramsey caller talked about this:

Brian called in to tell Dave about the time he went to a seminar for a vending machine company. He bought three $6,000 machines after hearing how much money they would make him. The machines barely brought in any money and Brian spent over $20,000 for this “lucrative” deal!

Research the items you’re buying, and know the tactics that businesses are using to get you to buy. They aren’t doing the deals because they’re a good deal for you, the customer. They’re in it to make money, and they know in the long run that you’ll lose out, and they’ll profit.

Wait 24 hours before making a major purchase

Always wait at least 24 hours before making a major purchase. Use that time in order to fully research the decision you’re about to make, whether it makes financial sense, and whether you really need the item. Often you’ll find that the item you just HAD to have, no longer interests you.

If after waiting 24 hours, discussing it with your significant other and making sure you have the cash to pay for it you still want the item move forward with the purchase.

I’ve found in my personal life that more often than not I end up not buying what I was looking at.

Always talk to your spouse before making a major purchase

Dave talks about how it is so important to keep the lines of communication open in a relationship, and that whenever you make a major purchase, you need to make sure that you’re discussing it with your spouse beforehand.

Many people would rather ask forgiveness than permission when buying something, but it’s important to remember that without discussing it you’re opening the marriage to a level of distrust and disharmony that you don’t need to be there. Discuss your purchase with your spouse, get their input (yes, they do have valuable things to say, I promise!) and then only after discussing it, make your purchase.

Next week

Next week is a lesson entitled “Clause and Effect” which deals with common traps to avoid when buying insurance of all kinds. See you next week!

June 30, 2008 · Filed Under Commentary, Dave Ramsey, Financial Peace University, debt snowball

1 Comment

Dave Ramsey’s Financial Peace University: Week 5 - Credit Sharks in Suits

Last week - dumping debt

Last week was week 4 in Dave Ramsey’s “Financial Peace University“. The lesson for week 4 was another good one, this time focusing on dumping all of your debt using the debt snowball! A few of the important points about how to dump your debt:

Quit borrowing more money. Don’t take on any more debt.
Cut up credit cards. Go cold turkey. Credit cards can mess up your budget on many levels.
Sell stuff. You have more than you need or use, so sell it and put the money towards debt!
Get an extra job. Take side jobs to accelerate paying off your debts. This can be temporary.
Debt snowball. Pay off the lowest debt first, then use the amount you were paying for that debt and roll it over to the next debt.

What was really stressed in this lesson is the need for your debt to be gotten rid of, because the borrower is slave to the lender. When you get rid of your debt you’ll be able to put your money to work for you - instead of for the people you owe, and wealth building can begin. Read the entire lesson here.

This week - Credit Sharks in Suits!

This week our class jumped into the topic of how to check and clean up our credit report and deal with collection agencies. Knowing how to deal with creditors can give you more confidence when working on your debt snowball that we talked about last week.

Some key points from this week’s lesson:

If you are unable to pay the minimum payments, use the Pro-Rata plan (see below).
Always budget for your necessities before paying off any debt.
Check your credit report for errors at least every two years.

Unable to pay the minimums? Use the Pro-rata plan.

Dealing with debt can be a very stressful situation, especially when it has gotten to the point where creditors are constantly calling you, trying to get you go make payments. This week’s lesson talks about how to deal with creditors when you’re coming up short.

If you’ve gotten into debt to such a degree that you’re not even able to pay the minimum payments on your debts, you need to come up with a plan where you are still paying some amount so that they know that you’re trying.

When you’re coming up short on the minimum payments, Ramsey suggests paying them on a Pro-rata plan. In other words, he is suggesting that you pay everyone a pro-rated amount, based on the amount you owe them, and the amount you have (total) to pay on all the bills.

For example, let’s say you have three debts, one of $500, one of $300, and one of $200 for a total debt of $1000. If the minimum payments for that month are for $50, $30 and $20, but you only have $80 left over after paying for essentials, the pro-rata plan would have you take your debt, figure out what percentage of the total debt it is, and then assign your money according to your debt’s percentage of the total debt.

So in our example, the $500 debt would get a $40 payment (50% of $1000), the $300 debt $24 (30% of $1000) and the $200 debt would get $16 (20% of $1000).

When you’re sending in your pro-rated payments, make sure to send a letter of explanation along with the check, telling them why you’re temporarily sending in less than the minimum. Give them a copy of your debt Pro-Rata plan showing all your debts, and the amounts you’re paying.

Some of the creditors may call and complain, and threaten to sue you, but making regular payments and staying in communication with creditors goes a long way towards keeping you out of court. As long as you’re making some sort of payment, most will not sue - although some will tack on extra late fees and other fees.

While this plan may help, it won’t solve the root of the problem, which is too much debt and not enough income. To solve that problem you may need to take on an extra part time job, or as Dave Ramsey says, “start selling so much stuff the kids think they’re next!”

Pay for the essentials first

Dave Ramsey told a story about a woman at one of his seminars who came up and told him that she hadn’t eaten in 2 days because she was paying some of her debts first. Ramsey stressed in the lesson that you should always take care of your families essentials first - food, shelter, transportation and clothing. The creditors come second.

If you can’t come up with the payments for your creditors, put them on a pro-rated payment plan as discussed above, and as stated - stay in contact with them. The better you are at doing that, the less likely they are to take you to court.

Dealing with creditors and collection agencies

When you’re trying to find your way out of debt, and you’re constantly getting collection calls it can seem like the bill collectors can do whatever they want. They can call you whenever they want and say just about anything just to get you to pay.

Dave Ramsey reminds us that there are certain rules that collection agencies and creditors have to follow when they’re contacting you. If a bill collector oversteps the bounds of the law, you can take action. The federal Fair Debt Collection Practices Act, or FDCPA, prohibits certain debt collectors from engaging in abusive behavior. Some of the things they can’t do include:

Call you repeatedly or contact you at an unreasonable time (the law presumes that before 8 a.m. or after 9 p.m. is unreasonable).
Place telephone calls to you without identifying themselves as bill collectors
Contact you at work if your employer prohibits it.
Use obscene or profane language.
Use or threaten to use violence.

For a more complete list go here.

Under the FDCPA, you have the right to tell a collection agency to stop contacting you. Simply send a letter stating that you want the collection agency to cease all communications with you. All agency employees are then prohibited from contacting you, except to tell you that collection efforts have ended or that the collection agency or original creditor intends to sue you or take advantage of some other legal remedy.

Ramsey suggests not doing this, however because often it will result in you being sued. Instead he says to tell them that they can call you once every two weeks, and that you’ll talk to them on that schedule. Any sooner and you’ll hang up.

It’s important to stay in contact with your creditors, or you may be headed for trouble.

Check your credit report

Stats have shown that over 50% of the credit bureau reports have errors. That’s a lot of errors!

In 1977 the Federal Fair Credit Reporting Act was passed. It deals with how credit bureaus, creditors and consumers interact. The FACT Act amendments to the Fair Credit Reporting Act requires the nationwide credit bureaus provide consumers, upon request, one free personal credit report in a 12-month period. You can check out your free annual credit report at the central source online at www.annualcreditreport.com .

Check your report every year or so, and make sure that there isn’t any strange activity on your report (which could mean fraud). Make sure that your information is correct, credit accounts that should be closed in fact are closed. If you see anything as it shouldn’t be, report it to the credit bureaus immediately!

Stopping the calls and the credit card offers

When you’re trying to get out of debt the last thing you need is to have telemarketers calling you and companies sending you offers in the mail for more credit. Stop those calls and that annoying mail.

Use the government’s National Do Not Call Registry to protect your number from unsolicited calls.

Stop all of the “pre-approved” credit offers that you get in the mail! You can have the credit bureaus turn away companies who check your credit report in order to send you unsolicited credit offers.

Next week

Next week wehave a lesson entitled “Buyer Beware” which deals with common traps to avoid when buying things. See you next week!

Bible Money Matters offers you 4 free issues of “The Economist” with this special offer. Click here to sign up now!
The Economist is a global weekly magazine written and edited for readers who share an uncommon interest in being well and broadly informed. With objective authority, clarity and wit, The Economist presents well-considered analysis of the world’s business, political, scientific, technological and cultural affairs and the connections between them.

LINKS:
Dave Ramsey’s 7 Baby Steps @ M-Network Blogs
ChristianPF.com - How to make a budget

June 17, 2008 · Filed Under Dave Ramsey, Financial Peace University, debt snowball, finance, snowflaking

1 Comment