Dave Ramsey is a popular and sometimes controversial personal finance talk show host. He is looked up to by thousands all across the country for his practical advice, and especially for his unique ability to encourage and motivate people to get out of debt.
While, of course, we wouldn’t endorse everything Dave–or any other person–says carte blanche, we find a lot of his advice to be generally very helpful. However, there’s one key strategy he promotes that other “financial experts” have often disagreed with: something Dave calls the “Debt Snowball.”
It works essentially like this: take a list of your debts and rank them by the smallest balance to the largest. Then take all your disposable income and throw it at the smallest debt first, paying it off as quickly as possible. Make the minimum payment only on the rest of your loans until the first balance is paid off.
Then, take the payment you were paying on your smallest account plus any additional disposable income, and begin paying that amount on your next loan until that one is paid off. You continue on from there until all your debts are paid off. He calls this the “Debt Snowball” method, because after each loan is paid off, you get a bigger and bigger amount of free cash-flow available to payoff the next debt (just like when a kid rolls a ball of snow to create a snowman; it gets bigger and bigger pretty quickly.)
You can read more about this strategy on Dave Ramsey’s website here.
This approach is different than what many financial experts would advise, which would be to rank your debts in order by largest interest rate to smallest, and pay them off in that order. That method has the advantage of paying the least amount of total interest.
So why does Dave Ramsey advocate the snowball approach? Probably because the advantage of the Debt Snowball is that its the quickest way to begin eliminating the total number of your debts, which carries with it the important psychological benefit of knowing you have one less debt payment to worry about, and that you now have additional free cash-flow available to knock out the remaining debts.
But some financial experts say this is the wrong strategy, because you aren’t eliminating the highest interest rate loans first. They argue that over the life of the loan, you pay more in interest using the Debt Snowball approach than simply by ranking your loans by interest rates, and paying them off in that order. Technically, they are right.
But what works in a spreadsheet may not always work in real life. A recent study by Northwestern University’s David Gal and Blakeley McShane shows that human psychology plays a crucial role in the results of any debt repayment plan. The key is whether or not the person sticks to the plan, and the Debt Snowball approach helps them do that, because there’s positive reinforcement every time a loan is knocked off the list.
My point here is not just that Dave Ramsey is right, but, more broadly, that motivation is crucial when it comes to reaching your financial goals. Just because a particular idea makes sense on paper, doesn’t necessarily mean it will work for you.
That’s why a personal financial advisor that knows you, your goals, and your situation can be very helpful.
