Passive Income

Last time we examined Baby Step #1, building a small emergency fund of $1,000. Building this fund is important because minor emergencies are a part of life. No matter what we do, something will come up that is outside your monthly budget. If you do not have money set aside for these circumstances, you will be forced to use a credit card; which is directly opposite our goal. As a quick reminder, here are the Baby Steps.

Introduction – Dave Ramsey’s Baby Steps – The Decision to Become Debt Free
Step 1 – Save $1,000 Fast – Build a Small Emergency fund
Step 2 – The Debt Snowball – Pay Off All Debt
Step 3 – Finish the Emergency Fund – Save 3 to 6 Months of Expenses
Step 4 – Maximize Retirement Investing – Invest 15% of household income into Roth IRAs and other pre-tax investment vehicles
Step 5 – College Funding – Provide a ‘Paid For’ Education for Your Children
Step 6 – Pay Off the Home Mortgage
Step 7 – Build Wealth Like Crazy – Then Give It Away

Baby Step #2 – The Debt Snowball

Once you have fully funded your initial emergency fund of $1,000, it is time to start tackling your debt. We do this in Step 2 – The Debt Snowball.

I am not going to sugar coat it. This step is a challenge! So much so that my wife are still in this step, 8 months after starting our Total Money Makeover. If you have large student loans (like we do), a few car payments or high credit card balances, it may take you as long as three years to finish this step completely. If not, consider yourself extremely lucky.

So exactly what is a debt snowball and how does it work?

Have you ever seen an avalanche on TV, maybe the discover channel or something? It typically starts with a small amount of snow. After a few minutes of rolling down hill, it picks up more and more snow, and speed, until finally, it is a massive wall of death and destruction. This is kind of what we are going for when using a debt snowball. We are going to start small and build upon each of our tiny victories.

Before you begin formulating your plan of attack, make sure that you have completed a written budget. It will be impossible to successfully completed your debt snowball without one.

 The Debt Snowball

• Make a list of all our your debts from the smallest amount to the largest. List ALL of your debts, except for you house (this debt actually is accounted for later on).
• After all of your necessities are paid (food, shelter, transportation and clothing), pay the minimum amounts on all of your debts. As a side note, you should be current on all of your debts before you begin this step. In fact, I think you should be current on all of your debts before you complete your initial emergency fund.
• Any additional money that can be squeezed from your budget should be applied to your smallest debt. This is extra money, in addition to the minimum payments that you are already paying. Do not consider interest rates when determining which bill to pay extra on. Pay off your smallest debts first and ignore the mathematics involved.
• Once you have completely paid off the smallest debt, put all of the money you were paying on that debt on the next smallest debt.
• Repeat this process until you are debt free, except for your mortgage.

Successful implementation of this process involves effort. It will not happen overnight. You need to get on a written budget, get current on all of your bills before you start and follow the plan. Some people suggest paying off the debt with the largest interest rate first. To be honest with you, the accountant in me wanted to do this as well. Once we started paying off tons of little bills, however, I could see the value in starting with the smallest one first. It is extremely motivating to have three or four less checks to write at the end of the month.

Have you completed your debt snowball? How good did it feel to finally say ‘no thanks’ to being in debt?

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