Thursday, August 26, 2010

Financial Preparedness, Part II

Previously, I discussed the first Baby Step towards financial freedom: a starter emergency fund of $1,000. Today I'll pick up with Baby Step Two: Paying off all your debt except your mortgage.

Debt will drown you.

In America we have this idea that debt is OK and a natural part of life. This attitude has only been around for the last 60 years or so. Credit cards as we know them did not exist until 1950 when Diners Club was introduced.

Credit cards may be convenient, but I think having real money in my pocket is even better! Some people try and play the system. They will charge up a low interest rate card and use OPM (Other People's Money) to invest and hopefully turn a profit. Others use credit cards for frequent flyer miles or rewards points and promise they will pay off their card faithfully every month.

I was one of those people, too. That was until I realized that until you are debt free, you cannot truly have financial freedom. Dave Ramsey often quotes Proverbs 22:7: "The rich rule over the poor, and the borrower is slave of the lender." This is very true and the more debt you have, the more true it will become for you.

What if you lost your job? What if that monthly payment got lost in the mail and all of a sudden your cushy interest rate gets jacked up sky high? What if you decide to have a mid-life career change and you have to go back to school? What if you get tempted at Pottery Barn and charge up way too many useless knick-knacks? Debt puts far too many "what ifs" in your life. Preparedness is about getting rid of as many "what ifs" as you can and debt has no place in the equation.

So what is the best way to pay down your debt? There are several schools of thought about this, but I subscribe to Dave Ramsey's plan. Baby Step Two is paying off all your debts, in order, from smallest to largest. Once you have paid off your smallest debt, you add the amount you were paying for the first debt to the minimum payment of your next highest debt. This is called building a debt snowball. Over time, the amount of money you will have available to attack each successive debt will grow, enabling you to pay off those big debts like vehicles and student loans.

Some people object to this plan and say you should pay off the debt with the highest interest rate first, regardless of how much it is. This does make sense in that you will save money in interest if you follow that plan all the way through. The problem with that isn't the math, it is you (and me and every other person out there who thinks it's more fun to spend money than pay down debt). If you pay off your debts smallest to largest, you will build momentum. You get quick gratification as you swiftly move through your debt snowball. If you start with the debt at the highest interest rate, you may stagnate if it happens to be one of your larger bills. It's like going on a diet and not seeing any change in the scale for 2 months. I'm much more likely to stick to my diet if I'm consistently losing a little bit every week rather than losing a big chunk all at once at the end of the two months.

This is the Baby Step Hubby Dear and I are currently on. We've been working our debt snowball for the last 18 months and we'll be done by the end of this year, having paid off nearly $80,000. Gulp. Momma knows how to shop.

Although we are not yet done with this Baby Step, we are already starting to have a greater sense of peace and control over our income. We have gotten rid of all of our credit cards and only use cash and debt cards.

Get rid of your debt! Pay off those bills permanently and don't get back into debt again.

Read much more about the Baby Steps in The Total Money Makeover. You can buy it on or You may also be able to listen to Dave on his syndicated radio show. Dave's the man!

Coming Soon: Financial Preparedness, Part III: The Dreaded "B" word.

1 comment:

  1. My DH and I are only 4 days away from the end of our first cash-only / on-a-budget month. I must confess that I'm not having much fun right now (which means that I'm not keeping the records I should be keeping). But in this short time we have completely changed our spending habits and cut our grocery bill by half -- with plenty to eat! Although it's old news, I've learned that it's not about deprivation ... it's about making choices about what really matters.