Dave Ramsey is one of America’s most renowned money gurus. He has a rabid fan base of followers whose main goal in life is to get out of debt and stay out of debt. Being debt free is the first step to financial freedom, and being debt free affords you the freedom to live your life the way you want to live.
Dave Ramsey has designed a 7 step system as part of his Financial Peace University. These steps are designed to be a broad road map to help people get out of debt and march toward financial freedom. Over the next two weeks or so, members of the M-Network are going to explain in detail, the 7 Baby Steps. For now, here is an overview to the 7 Baby Steps, and a little background about them.
Step 0 - No More Debt!
Step O isn’t officially listed in Dave Ramsey’s 7 Baby Steps. But making a conscious commitment to change is essential before you will be able to accomplish any of these steps. It is nice to say you will do something, but another thing entirely to follow through with it. Once you make the commitment to live debt free, the following seven steps become easier to accomplish.
Step 1 - $1,000 to start an Emergency Fund.
Emergency funds are quite possibly one of the most important things you can do for yourself financially. You never know when you will need quick access to several hundred, or even a couple thousand dollars to deal with a car repair or a quick plane ride to visit family who live far away. An emergency fund will give you the funds to take care of these expenses as they arrive, and help you stay out of debt.
Step 2 - Pay off all debt using the Debt Snowball.
Dave Ramsey advocates using a debt snowball to pay off debts. Some people refer to this as “snowflaking,” which refers to taking small amounts of money (snowflakes) and combining them into a larger amount (snowball). Those small amounts of money can add up quickly, and a snowball is much more effective than a small snowflake. Ramsey advocates taking every small amount you can save and applying it toward your debt - instead of spending it on frivolous items. This concept has really taken off in the personal finance blogosphere, and has even spawned a Snowflake Revolution website and a network where members share how they have applied the snowflaking principle to debt reduction, investing, or any other applicable financial goal.
Step 3 - 3 to 6 months of expenses in savings.
So you have an emergency fund, and you have paid off all your consumer debt… what’s left? Extended savings. An emergency fund is great if you need new tires, need to fly cross-country to attend a sick or dying relative, or need major car repairs. But what happens if you get laid off, or need a new roof, or you get injured on the job and are out of work for several months? Unemployment and disability insurance will be of some assistance, but they aren’t likely to cover all of your expenses. Your roof? Unless you can cover that with cash, you are liable to have to go into debt, erasing everything you worked so hard to accomplish in Baby Step 2.
Having 3-6 months living expenses at your disposal will make it much easier for you to make it through an extended period where your income does not match your expenses. Having this money gives you freedom. Freedom from worrying about one small slip forcing you back into crushing debt and the associated pressures that come with it. The best course of action is to save this money in a high yield savings account such as FNBO Direct or ING Direct where you can earn a solid return on your money.
Step 4 - Invest 15% of household income into Roth IRAs and pre-tax retirement.
One of the best financial feelings I can remember was when I first saw some real growth in my savings. When I was younger, $10 represented over 2 hours work for me. Then one month, after I had been saving for several months, I looked at my bank statement. I had earned over $10 in interest. My money was working for me! Nowadays, $10 doesn’t seem as much to me, but the concept remains the same. You need your money to work for you if you are ever going to be financially free. Saving for your retirement in tax advantaged accounts is the best way to make progress for long term savings.
Dave Ramsey recommends investing 15% of your household income (or more if you can afford it) into Roth IRAs and pre-tax retirement accounts. I agree with Dave, Roth IRAs are better than Traditional IRAs. If you are considering a pre-tax account, your options are generally a Traditional IRA or a 401(k), or equivalent. Whether you choose a 401(k) or IRA will depend on your situation.
Step 5 - College funding for children.
By Step 5, you should have an emergency fund, be out of debt (except a mortgage), have 3-6 months living expense to cover major life events, and already be contributing 15% or more toward your retirement savings. If you have children, your next major expense will likely be college. Should you pay for your children’s college expenses? The answer varies from parent to parent, but you should be aware of this - when colleges process student loan and grant applications, they often take into account parental income levels.
Whether or not you assist your children through college is a decision you will have to make on your own. But there is one thing I like - Dave Ramsey recognizes it is very important to place your retirement savings ahead of college savings for your children. You only get one shot at retirement, and you can’t borrow your way through it. College on the other hand… You can receive loans and grants, which can be borrowed and repaid.
Step 6 - Pay off home early.
Many people debate whether or not it is better to repay mortgage debt early, and there are strong arguments for both sides. Mortgage debt is generally inexpensive debt and mortgage interest is a tax deduction for most people. Investing money you could use to prepay your mortgage could potentially earn you much more money in the long run.
On the other hand, mortgage debt is still debt. If you already have completed steps 1-5 and have additional funds every month, paying off your mortgage early will free up more money every month and allow you other freedoms that you would not have with a mortgage.
A friend of mine is in his mid-thirties and paid his mortgage off completely. This allowed his wife to quit work and stay at home to raise their three children. They have no other debts, and he recently took a lower paying job because it brought him more satisfaction at the end of the day. He wasn’t trapped by an enormous mortgage, or saddled with other debt. Being debt free allowed his family to make these decisions to live the life they want to live, not live the life they are force to live to just to repay debt.
Step 7 - Build wealth and give! (Invest in mutual funds and real estate).
This is Dave Ramsey’s final baby step. In my opinion, this step is open to interpretation based on personal beliefs, needs, and situations. I understand each element, but in my opinion, it seems like a couple different ideas were thrown together into one step. Let’s break them apart and examine them one by one.
Building wealth: With no consumer debt, a large fall-back fund, 15% or more of you income going into retirement accounts, your children’s college paid for, and your mortgage eliminated, you may have extra funds to play with every month. If so, wealth building is the next logical step. Of course, by investing for retirement, you have been building wealth all along. But, I suspect Dave Ramsey is referring to building non-retirement wealth.
Ramsey mentions investing in mutual funds and real estate. I would prefer to invest in index funds over mutual funds because the fees are generally much lower, but the idea is the same. As for real estate, the reason I believe he mentions that is to grow an alternative income stream; something that will bring in income outside of your normal job. I commend this type of thinking, but real estate is not for everyone. However, I believe alternative income is important for everyone to strive to achieve.
Invest to build wealth, but make the types of investments that suit your needs.
Giving: Dave Ramsey is big on giving, and advocates tithing 10% throughout all the baby steps. Giving, by his definition, is anything about 10%. Giving is a very personal thing, and not something you should rely on someone else to tell you how or when to do. You should do what you believe to be the right thing to do.
I should also note that if you are tight on money, there are other ways to give. Giving of your time, energies, talents, or other forms of giving can often make a greater difference than just throwing some money in a pot.
Dave Ramsey’s 7 Baby Steps: Wrap-up
Overall, I think Dave Ramsey’s plan is a solid plan to get out of debt, build wealth and reach financial independence, and ultimately, financial freedom. There are a few caveats though - this plan should be viewed as a rough guide, and not an absolute road map. Everyone has different personal and financial situations and goals. But if you are able to use this guide as a rough outline, your chances of meeting your financial goals are very good.
Stay tuned this week for more in-depth articles covering these topics.
- Dave Ramsey’s Baby Steps Overview - Cash Money Life
- Step 0: No More Debt! - Single Guy Money.
- Step 1: $1,000 to start an Emergency Fund - Gather Little by Little.
- Step 2: Pay off all debt using the Debt Snowball - I’ve Paid For This Twice Already.
- Step 3: 3 to 6 months of expenses in savings - Being Frugal.
- Step 4: Invest 15% of household income into Roth IRAs and pre-tax retirement - The Dough Roller.
- Step 5: College funding for children - My Two Dollars.
- Step 6: Pay off home early - Moolanomy.
- Step 7: Build wealth and give! - Plonkee Money.
- Wrap-Up: Baby Steps Overview - Being Frugal, Baby Steps Review - I’ve Paid For This Twice Already.
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{ 49 comments… read them below or add one }
Just a few points:
Dave Ramsey does not use the term “snowFLAKING” that one was coined in the pf blogosphere
Also, DR says to be tithing (10%) throughout the Baby Steps, and “giving” is anything above that 10%.
Baby Step 4 is capped at 15% of income until you have the mortgage paid off.
Steps 4, 5, and 6 are to be done concurrently if income allows.
-Ana (the “rabid” Ramseyite)
Ana, Thanks for the comments. I do not confess to be a Ramsey follower… To be honest, I had to go out and research the baby steps. I’ll make the corrections. Thanks!
Patrick: great article. His one step that I disagree with strongly is #6. For most people with mortgages the interest rate is so low (5% in my case) that it is a waste of money…there are SAVINGS accounts with higher interest than that. That doesn’t even take into account tax savings via deducting interest. For me it is huge at least. I remember reading a while back a book called “never pay off your house” or something like that. Random note, but it was an interesting read.
Jesse, paying off mortgages early is one area which people may not ever agree. Going by pure numbers, it may make sense to keep your mortgage payment because of the low interest and tax deductions. But on the other side, there is the psychological effect of not having any payments. I know that when my friend paid off his house and no longer had any debt, he and his family had a new outlook on life.
I think the rationale behind paying off your mortgage is to be completely debt free. That has to be an amazing feeling knowing that you don’t owe anyone anything.
I can see it both ways.
@Jesse, now I’m really curious. Just where are you getting a SAVINGS account with better than 5% interest? Especially with all the Fed rate cuts, and more expected?
Hey Patrick nice summary here. I’m looking forward to reading the series.
I often write about the positive psychology behind many decisions (it’s often more important than what the numbers tell you)… I like what your friend did in paying off his house… it worked for him and his family which is great.
It could be different for someone else, that’s why everyone’s plan will be different and should be. You start with a blank canvas and customize your plan to your tastes, your family’s tastes and what works best for you.
No 2 snowflakes are ever a like…
I agree with Jesse on #6. I do realize though that for some people it makes sense in their heads to pay off the debt early, and sleep tight at night. But in my opinion people who are afraid from debt would not end up with a lot of assets in the long term.
My thinking is that the longer you stretch your payments, the better, because eventually inflation would significanlty erode the purchasing value of your fixed payment at year 30. And in the meantime, you could have put those extra funds in stocks gaining from all the time you have on your side and the power of compounding.
I’m glad he also encourages and advocates charitable giving. I think it should be part of everyone’s portfolio to give some to charity, whether it be for church or other reasons. It’s not only honorable and helpful to society, it’s also a move with some wise tax benefits as well.
-Raymond
Trust me, when the time comes to pay additional on MY mortgage, there will be zero hesitation.
Someone please explain how it is to my advantage to pay a mortgage company $12,000 in interest just so I can deduct that $12,000 from my taxes.
The spread is too small to bother with. The mortgage is compounded daily, the savings account quarterly or monthly.
I’m a PAY IT OFF guy. I don’t think anything could compete with that peace of mind.
I’m excited to follow this series. I just finished reading Total Money Makeover. I like a lot of his thoughts on changing your behavior to get a better financial outcome. I;m now going back and checking the statistics he references. (I have an older edition.)
I consider myself a Dave Ramsey junkie, and really enjoyed this post as it is a great overview of his Baby Steps. Nice job!
Looks like JD read your mind with his post this morning. I’m sure that that was planned in advance, funny timing.
I tell you one thing, it can’t hurt Dave Ramsey’s book sales…
Something must be in the water. Last week I started a personal finance 101 series (my blog’s about simplicity in general, not necessarily just pf), and today I wrote about baby step #2.
I’m a big Ramsey fan. One thing you need to realize about him is that he knows some of the advice he gives doesn’t coincide with the math. You have to keep in mind his philosophy that he believes personal finance is 80% mental and 20% about the math. I agree with this. The decisions you make have so much more to do with how much money you will have rather than being a whiz about the math. Understanding the math and actually being diligent and self-disciplined are two VERY different things.
Erik, I agree, there is a huge personal element in finances that has absolutely nothing to do with pure numbers. Perhaps the best example of this is the prepaying mortgage issue. Some people look at the raw numbers and determine they can probably get a better return by investing extra money in the stock markets. They probably can over the long term. However, the freedom of not having a mortgage payment is HUGE, and one that many people are willing to forgo extra returns to be able to live their dream of not owing anyone anything.
Self-discipline is another matter entirely!
I have listened to Dave Ramsey on the radio for years and I am debt free and it was definitely his influence that has me where I am financially.
Not that I am rich, but I have been able to withstand some financial hardships with little impact by being debt free.
Definitely a great man to pay attention to. Entertaining too.
As is the case with any public figure, there is always someone else with something bigger, better or faster. Fact remains, Dave Ramsey is a genius. He is the first person to not only come up with a simple (not easy) plan, but has the marketing prowess to garner such adoration from his audience. Teaching people how to live within their means. Beyond the math, he also influences us in a way to be happy & content once we reach that pinnacle.
Ramsey’s baby steps seem to be common sense and easy to understand, but as a young person(24) it seems unrealistic even without a house note. (Granted my salary isn’t as large as one would hope to have after graduating college) How can one save $1,000 for emergency funds plus 3-6 months of wages, give 10% to charity, AND put away 15% to retirement? All of my money goes towards loans from college, car notes, and car insurance (thankfully my job has a mandatory retirement plan, in which I only put in 5%!). I just don’t see how these baby steps are plausible with all the other extra bills in life. Please help me understand…maybe it’s just my age and my starting in the “real world”? Or this plan takes years and years to achieve?
I am also 24 years of age. These are called baby steps for a reason. Just take it one at a time. For your 1,000.00 Dave Ramsey advises a yard sale, (at 24 I don’t have much to sell) an extra job, cleaning cars, mowing lawns any thing to make extra cash. Lets say you can only put 100.00 a month extra. In that case congrats in 10 months that is taken care of. There is no time frame on the steps. The nice thing about the 1000.00 is you can keep from putting money on a credit card for stuff you NEED. Then take that extra 100.00 and put it towards your college loans. If I were you I would put more than 1,000 in my emergency fund if your loans are higher than 10,000.
This plan does take years, by putting in your %5 that is a good start, if you are in a job where you get a raise avg I THINK is around 4%. Put that money into your account when you get the raise or take 1/2 of it. in 4 years you are done with your next baby step. if you are able to not take the raise at all you will be there in 2 years (I think Dave would tell you to take the raise and keep paying off debts first then start to invest.) Now you need to work more on the student loan. Getting out from under a new car always helps also Dave goes in to a large talk in his class about not having a car payment. Do you go out on Friday nights? Paintball, for me it is fishing and hunting, well put a cap on the $ you are able to spend and put the rest on your college loan. After that if you want to keep the car, start paying that down…. if you take the Dave Ramsey class it all makes more sense. It can be done, who gives a hoot if you don’t follow his plan 100% the idea is to get something going and take control of your own $ you will always need $ so it will always be a learning process.
Does anyone remember the name of the book that Dave Ramsey talks about from time to time, regarding co-dependency????
Olivia,
I’m sorry, I’m not sure which book that is.
All of your house interest is NOT tax deductable. The only amount that truely is, is the amount that is above the standard deductions. Myself I can’t wait to get my house paid off. I had a 15 year loan and in 4 years I only have half of it left.
Jim,
I can’t wait to get my house paid off either! There are two schools of thought on the topic: pay it off ASAP, or stretch it out as long as possible and invest for higher returns elsewhere. Right now I am of the first school of thought because having no mortgage gives me a different kind of freedom. But ask me again in a few years and I might change my mind.
I like the debt snowball concept and having the expenses of a few months in advance also helps. Just came across this blog, a very interesting read.
Dear Dave,
My husband and I just started a budget. This is the most overwhelming thing that I think we have committed ourselves to do. Tell me, Dave, did you feel this way? Most of the problem is that we have never, in our 39 years of marriage, been out of debt. This is a new beginning for us. We have a long ways to go but we intend to stick with a budget and get out of debt. Thank you so much for your program and The Total Money Makeover. I can’t get enough I watch everyday to see if there is something to inspire me and it never fails. Thank you so much for helping us find a way to get debt free.
Bonita
Gulfport, MS
Bonita,
Thank you for contacting me. I am not actually Dave Ramsey; my name is Patrick and I am a personal finance blogger. Basically, I am a regular guy who writes about my hobby - which is money and financial planning. Some friends and I wrote a series about Dave Ramsey, which is how you found my site.
Regarding your new budget, congratulations! Yes, it can be intimidating, but it is an important first step toward becoming debt free. Congratulations on your new beginning, and if you need assistance finding more information about how to become debt free, don’t hesitate to contact me. I will do the best I can to point you in the right direction.
Paying off your mortgage is a 100% risk free guarantee return of investment. If you pay off a 5% mortgage, you are getting rate of return on money not owed. You will also pay less interest in the long run which will be better than any money market fund you can park your money in. The tax deduction is close to a scam. You pay 1,000.00 in interest to get a $250.00 tax break. If you have no mortgage, you can accomplish the same thing by donating to charity. That way, the bank isn’t getting your money.
Jeff,
That;s a very good point. Paying off your mortgage early does tie up your money in equity, so it is a good idea to leave a large enough emergency fund so you won’t need to pull out a home equity loan or use other forms of credit.
Jeff,
That’s a very good point. Paying off your mortgage early does tie up your money in equity, so it is a good idea to leave a large enough emergency fund so you won’t need to pull out a home equity loan or use other forms of credit.
Interesting; I’m totally not familiar with Dave Ramsey though I’ve heard his name (maybe it’s because I’m in Canada and his media doesn’t circulate as much up here).
I would add with regard to the emergency fund that it is really important in order that you don’t have to tap into any INVESTMENTS that you may have compounding for you.
I’m not an advocate of paying off all debt first and proceeding to get one’s financial life “in order” in a linear fashion. I start all improvements all at once. But these steps are all still important, of course.
Money Energy,
I agree, tapping investments should be the last option.You can certainly start all improvements at once, and DR actually advocates this for the later steps in his program. Some of the steps are more important than others and should be accomplished first.
I have listened to Dave Ramsey since I was a child riding in the car with my parents. Now I am an adult and listen to him all of the time. I have read all of his books and try to catch his show on Fox. I love what he teaches and wish we could spread the word more widely about him.
To bad your not neutral and open minded enough to include all comments pro or con.
Hello Scott,
Thank you for contacting me. I do not know why you think I am not neutral in allowing comments that don’t agree with what I write. I welcome all comments that are on topic, so long as they are respectful and do not contain curse words, spam, or commercial links.
I welcome dissenting views because that is one of the ways I learn best - to look at things from another perspective. (I love to play Devil’s Advocate when analyzing a situation and it drives my wife crazy!).
For more information, please review my Comment Policy.
Some comments are held for moderation. I have an anti-spam feature on my site which automatically blocks some first-time comments and other comments that may be questionable. I do this because otherwise I would receive hundreds of spam comments everyday - for things like pharmaceuticals, porn, payday loan companies, commercial websites, and comments filled with curse words. As you can imagine, these are unwelcome on my website and I do not tolerate them.
As you probably noticed, your comment was initially held for moderation. I go trough my moderated comments once or twice per day and I immediately approved your comment. If you leave another comment it will probably go through immediately.
I appreciate all visitors and I hope you will take the time to visit again.
Hi Patrick. I am a woman of 53, and I am debt free. My home, my cars (2 caddy’s), my mule, anything and everything you can imagine is paid for. I have just started an Avon business, because I am retired, I wanted to do something to make the world look and smell beautiful, so I chose Avon. I have investments that pay me $5,000 a month, and I use Edward Jones to invest the money I receive. My problem is….I love to shop, and if I don’t stop , I will lose my fortune. Any ideas of what to do? Yes, it is an illness, I agree. I need something to replace this addiction. Got any ideas??? Plz reply soon to my e-mail address if you would be so kind.
thank you very much…Jen
ps I also give to my church 10% each month
thank you again, Jen
100% of foreclosed homes have a mortgage
It isn’t that people are afraid of debt. I understand the argument of why pay off my mortgage that is 5-6% when I can make 7-10% on my investments. (Tell me where in this economy) But what happens when you get laid off? I know rich guys thing that will never happen (Lehman Brothers anyone?) I’d rather make less for a few years while paying off my mortgage than be earning 8% on investments then having to withdraw them because I am unemployed. Just my $.02
People do it every day and the quicker that your learn it the better off you will be. Oh if all of us that are older had only LISTENED when we were 24!
Good luck… you really should read the book.
Jesse, let’s put a spin on it the way DR would.
If your mortgage was paid off, would you go and borrow money against your house to invest?
I hope not!
(All of you loyal Podcast listeners know what I’m talking about.)
Ron, Agreed! There is no way I would borrow to invest. It just doesn’t make sense!
Everyone talks about the mortgage interest deduction but here’s the deal: it only makes sense to take the deduction if you itemize your deductions. Even some people who buy homes don’t have a tax situation that justifies this–they get more of a refund taking the standard deduction. I was in that boat with my then-husband when we bought our house in the late nineties.
Even if you can justify itemizing, it’s not worth staying in debt just to get a measly tax credit. There are other ways to get tax credits that don’t risk the roof over your head.
Because in the end that’s really what it’s about. One commenter from a year ago said that anyone who pays off a house is probably a little bit afraid of debt. Yes, everyone should be. As long as you owe someone money, you’re more or less their servant. (I’m not a Christian, but I agree with this idea.) If you’re going to go into debt to create wealth, it is wiser to incur that debt in an area that doesn’t risk your job, your health, or your home.
People seem to get confused about these things when they talk personal finance. They think a personal home and a savings account are investment vehicles. Big mistake. Thinking of either as an investment vehicle leads to bad financial decisions that could cause you to lose more in the end. Think of all the people being foreclosed now, or of the people who bought into the idea of spending their emergency savings to pay off a credit card (”you pay more in interest on a credit card than you get in your savings account!”) and then lost their jobs.
Dana: I agree, debt has a much larger impact on financial security than many people realize. There are many people that just accept debt as a way of life and never aspire to reach the point of being debt free. I don’t plan on working into old age just to be able to make payments on material things. I plan on living within my means and working to pay everything off so I can enjoy financial freedom and spend time with my family and doing things I enjoy.
Dear Dave,
My husband and I are presently attending your Financial Peace University. We have completed baby step 1,2 and 3. I have a 30 year mortgage. Unfortunately we refinanced the house 3 years ago at a interest rate of 6.5% and owe about $320’000. The house appraises right now for about $400. My husband and I have been making 1 extra payment each year sense we refinanced the home. We divided that payment in 1/12 payments and added it to our regular mortgage payment and applied it to our principles. Right now we are in the position to make double payments each month. But this would really limit us from making any spontaneous decisions like going on short weekend trips and so on. What would you recommend?
Thank you for taking the time of responding.
Martina
Martina, Dave ain’t here…
A useful post nonetheless and a good round-up of the baby steps. Well done.
the Dad, climbing out
The first few Baby Steps are easy (do without, see progress, reach goal in a reasonably short period of time) compared to trying to live the Ramsey way later in the steps (keep emergency fund fully funded, save for cars, pay off mortgage, keep investments at 15%). There is very little discussion about this by Dave or anyone else. Is anyone else experiencing this? Can anyone make suggestions where to find some support for people like me?
babsnea: This is where having a strong budget comes into play. You will need to consistently spend less money than you earn, and use the left over money for the things Dave Ramsey recommends. A lot of this will depend on your income and many other factors. Some people simply do not earn enough money to save very much. But if you earn enough to save, then you will need to create a solid budget and stick to it.
My wife and I have been working Dave Ramsey’s baby steps for a little over a year now (working toward accomplishing #3) and our whole perspective on money has changed. The challenges experienced through living the baby steps long term really stems from your view of money. If you initially approached these baby steps as one approaches a diet you will likely not have the will power to continue long after you begin. Dave Ramsey is trying to instill in people a life style change, not a diet. If you make $40,000 per year, your consumption must be something less than $40,000 per year or you will never achieve anything. This caused a paradigm shift in how we see money. We got off the earn-to-spend cycle, but that is a choice and I think you have to get mad before you make that decision.
Dividend Growth Investor,
Borrowing money to invest is stupid.
1. Risk. Stretching the money over 30 years in order to invest will not put you ahead if lets say the stock market falls 50% along with home values…such as the situation that we are in now.
2. Taxes. Paying 6% interest in order to make 8-12% in good markets may sound like a good idea, until you have to pay taxes on the capital gains and dividends which will more than likely increase greatly.
3. Cash is king and a great asset. Someone making 50000 per year can build wealth with no debt while one making 100,000 per year with a mortgage and 2 car payments will not be able to build wealth or be able to not live paycheck to paycheck.