Step by step guide to implementing the Dave Ramsey’s Debt Snowball

In our consumption society, is it any wonder that the average American has about $15,000 in credit card debt? Nearly everything we buy is designed to fall apart so we are re-consuming many of the same things over and over. Credit is essential for a robust economy and provides financial stability for our country, however there’s a cost to living this way as well. There’s an actual economic transfer from cash payers to card payers as well as a psychological cost to those who burden themselves with debt. The psychology of debt is interesting.

Most credit card companies are preying on our innate desire to show off and prove our worth and value.

Debt is simultaneously the great facilitator of wealth and the great underminer of personal finance. It’s very difficult for the average person to measure the real cost of purchasing with debt when the credit is easy to get. There’s a great little spot in the Bible where Jesus says, My yoke is easy and my burden is light. The implication is that by serving others, loving our neighbor, and following his teachings, we’ll find peace. Our consumer based society pushes the opposite reality of a place where the things you have matter most. Consumer debt (mostly credit cards) is the machine that generates the consumption and it creates a heavy, heavy burden that is very difficult to remove.

Getting out of Debt

1. Simply your life by cutting up your credit cards and consolidating your bank accounts. Cancel your accounts if you want. In the long run your credit will be better off. You will feel better and the fewer choices will be a relief to your overburdened mind. It’s the Paradox of Choice in credit card form.

2.  Figure out how much you owe. How do you find out how much you owe? You have two options: Paper or electronic.  You can pull out the paper copy of your latest credit card statement, student loan statement, etc. and list the unpaid balance from the top of the statement. The interest rate is going to be on the second page.

3. List it all in one place. I really like the debt calculator spreadsheet from Vertex. Here’s a sample on Dropbox that you can see what it is supposed to look like. I like this spreadsheet because it gives you a few important options related to which debts you pay-off first.

4. List debts by smallest balance first. This is called the “Debt Snowball” means you pay off your debts from the smallest balance to the largest balance and include the monthly payment for each debt into the next largest debt’s payment.  This is also known as The Dave Ramsey method and it drives financial people crazy because it costs you more over the long run. So why recommend it? It has been proven to help pay off debt faster due to the psychological benefits that come from small wins and small progress.  David Gil and Blakely McShane from the Kellogg School of Business explain:

“The idea is that starting small “could motivate you, because you check something off your list. It can make you think that you potentially have it in you to complete the whole list. `Hey, I’ve achieved this! I wasn’t sure whether I could do it, but I’ve got one of these items, so maybe I can.’

That suggests that just having some small task to tackle early on might motivate you to get started. From a rational perspective, you should always pay the higher interest balances first. And that’s what people have recommended in the past. But what we’re saying is, there’s another factor to consider.”

Your other alternative is to list debts by interest rates. Put the highest rates first and pay them down first. This is the Debt Avalanche and from an economic sense it is the best way to pay off your debts.

5. Start tracking your spending. Personal Capital did a study and found that spending went down on average by 15.7% for those who download and used the Personal Capital financial app. Keep in mind, this isn’t budgeting, which most of us hate. It’s just tracking your spending. Again, there’s a psychological affect at play here where merely monitoring expenditures tends to keep you from spending more than you normally would. It makes sense seeing how must of us spend so much time looking at our phones.

6. Start cutting costs. Everything should be on the table here. Your personal finance grandpa, Dave Ramsey, says that your family should eat beans and rice until you’re out of debt. Early retirement guru and personal finance extremist Mr. Money Mustache calls it an emergency and wants you to put off everything until it’s gone. Either way, you have to cut costs and make significant sacrifices or you’ll never get there. Until you take it seriously and get your spouse on board, it just won’t happen.

Once you are out of debt, it’s time to tackle a host of new opportunities, but there’s no sense in trying to skip step 1. If you take the steps above but can’t stop spending and your debt keeps mounting, it’s time to get serious help. As in talk to your doctor or psychologist. This modern world has entrapped you and it’s time for serious help.