I have stated before that I am huge Dave Ramsey fan. I think his approach to debt destruction is the simpliest and most straightforward approach. It has broad application across all income levels and focuses on motivating people and changing their behavior. I used the baby steps and the and free access to Dave’s radio show to eliminate $70,000 in 4 years.
There are officially 7 baby steps(1-7), but there is an unofficial pre-requisite that I like to put in there.
Step 0 – Stop going into debt : If you don’t stop the leak you will never be able to repair the damage. Simple as that.
Step 1 – Save a baby emergency fund : Pay minimums on your debt until you save $1,000. The purpose is to keep you out of debt when unexpected costs arise. If you deplete this fund for anything, halt the baby steps and start at step 1 again.
Step 2 – Pay off all debts, except for a first mortgage : Do this using the ‘Debt Snowball’ which is paying minimums on all of your debt except the smallest regardless of interest rate. When that debt is gone, snowball all available money into the next smallest debt. The point here is that small victories create confidence and motivation. It changes your relationship with money and spurs you on to attack the rest of the debts. This step is designed to be a full out frontal assault not a leisurely stroll through the park. Sell everything that isn’t nailed down, cut cable, movies, eating out and use the extra money for to grow the snowball.
Step 3 – 3 to 6 Emergency Fund : Relish in being debt free except for a house while using the money to quickly store 6 months of expenses. The purpose here is to shield you from major catastrophes which do happen like job loss, disabilities, fire, theft, etc. Personally, accomplishing this was the single greatest feeling, even better than paying off our consumer debt.
Step 4 – Invest 15% of your income into your retirement : Use Roth IRA’s and pre-tax retirement accounts to purchase good solid mutual funds with solid track records.
Step 5 – Fund College Savings : Skip this step if it isn’t applicable or you aren’t planning helping the children financially. Education Savings Account and 529 plans are good options.
Step 6 – Pay off the house. Use all extra money to pay off the house what will most likely only take a few years.
Step 7 – Build Wealth and Give.
I know that sounds simple and obviosuly there are nuiances to each step which aren’t covered like budgeting, insurance, and picking good mutual funds, but once you develop the discpline, control your spending habits, and change your money behavior during step 2 you will most likely have the energy and behaviors that will make all the rest seem like a cake walk.