I’ve not thought too much about Dave Ramsey for some time, not since before I adopted this format and was writing a monthly article. In one article I discussed his Debt Snowball, and quote him as saying “Myth: I should pay off the debt with the highest interest rate first to get out of debt quickly. Truth: You should pay off the smallest debt first to create the greatest momentum in your debt snowball.” I understand when authors are responding to a question from a reader often don’t have the time or space to offer as detailed a response as they might like. This statement, however, was on his site as a rule to follow, and he even added, “The math seems to lean more toward paying the highest interest debts first, but what I have learned is that personal finance is 20% head knowledge and 80% behavior.”
A few weeks back Adam Baker of the site Man vs Debt showed me another spin on the paying down of debt in his “Debt Tsunami: The Ultimate Method For Paying Off Debt.” No problem with this, Adam acknowledges the differences in payoff methods, and suggests that one should lower their stress while lowering their debt. (I like that idea, and his approach.)
Then, I read Four Pillars Is Dave Ramsey a “Financial Expert” and this prompted me to start polishing a spreadsheet and newer article I’d been working on to take another look at the Snowball. To clarify, if you’ve not heard of Debt Snowball yet it simply means that you line up all your debt by balance. You then make the minimum payments on every debt, except you pay any extra money budgeted to paying off the smallest current balance. I’ve always claimed that paying in order of rate is the right way to handle this.
Late last week I read another article, Fiscal Geek’s The Debt Snowball Saved my Marriage: Spreadsheet Tell-all and found via his site, a spreadsheet The Debt Reduction Calculator, which amazingly, offers a pulldown tab which allows you to choose your method of payment.
First, Dave’s Debt Snowball:
Then the Debt Avalanche (paying highest rate first):
Wow, the difference is $4381.62, quite a difference. Now, to explain, the most dramatic difference comes from the wide spread from high rate to low, as well as the balance on the high rate card. Would you really feel better paying those smaller balances so quickly once you learned that those good feelings came at such a high cost? I didn’t think so. And my experience shows that your lowest rate cards may very well be the cards with the lowest credit lines as well. So you might have four cards each owing $2000 at 10%, but one card with a $10,000 balance at 24%.
Tell me, does this put an end to the Snowball debate?
Joe
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July 6th, 2009 at 8:51 am
Thanks for the link. Good analysis!
July 6th, 2009 at 10:24 am
What debate? I guess that it can only be a debate to someone who’s racked up $25G at 25% in debt. IOW, someone who thought “tomorrow be damned, I want this or that now because I deserve it.” Well, deserve it one does.
July 6th, 2009 at 10:56 am
As you’ve observed, I’m a numbers guy. The debate regarding Dave Ramsey’s ‘Debt Snowball’ has been that the numbers show paying High Rate debt first is better than Dave’s method of Low Balance. Of course, I set the example shown to favor my position, to contradict Ramsey’s stance of “do it my way,” as if his is the only method. Is $25K of credit card debt so out of line? I don’t think so. Above average, but not unheard of.
July 6th, 2009 at 12:43 pm
$25G is still out of line for any mature adult… Maybe such an overgrown adolescent needs to “feel good” rather than to feel responsible.
July 6th, 2009 at 1:13 pm
Agreed. I’m not passing judgment (on these debtors), this train of thought assumes they are out there, and hoping to get them on track with their finances. I’m also hoping that readers who see these crazy numbers will take some advice and not get into this kind of mess.
July 6th, 2009 at 1:44 pm
If you accept Dave Ramsey’s belief about behavior being the #1 factor and math being #2 then the debate is still ongoing.
If someone can get motivated by paying of a small balance credit card and cutting it up and then continue on with debt payoff, good for them.
That same someone, might get discouraged after only paying off 2000 dollars on a 10000 card and still owe 8000 and think its taking too long and quit.
In this case, this person might end up paying a lot more in interest overall then with Dave Ramsey’s method.
Everyone gets their motivation differently. I lean towards the Math approach, but if you pick a different method, as long as the debt is being retired and your motivated, good for you.
July 6th, 2009 at 1:59 pm
Dan, my problem is not with behavior, let me acknowledge your point, and agree especially with your words,”Everyone gets their motivation differently.” My issue is that Dave dismisses the best mathematical way to do it, calling “I should pay off the debt with the highest interest rate first to get out of debt quickly” a myth. He does his readers a disservice to use that as an example and steer people to his method. I view him as arrogant and his advice, flawed. At the very least, I offer the cost of doing it either way, through the sheet I linked to. If the difference is a few hundred dollars, and you can get rid of the nagging 3-4 card statements, that may be your choice, what’s right for you. But another mix, as in my example, will cost you dearly. He doesn’t mention that.
July 6th, 2009 at 2:25 pm
JOE,
I occasionally listen to Dave Ramsey if I’m in the car and it’s on. Many of the people who call in tend to be illiterate when it comes to money. I agree he appears arrogant when it comes to him expressing his opinion as fact. For his audience it seems like he tries to keep things as simple as possible. For those people that seems to be effective.
BTW, I enjoy your site. You have a lot of good info and insights. I ran across it a year and a half ago or so when I was looking at the money merge account with UFF. Talk about a waste of money!
July 6th, 2009 at 11:18 pm
[...] JoeTaxpayer has a simple illustration of the ‘debt snowball’ and the two different methods of paying down debt: paying debts with highest interest rates first, [...]
July 7th, 2009 at 12:55 pm
I wonder if the spreadsheet could be concocted in such a way to achieve both: getting rid of a lower balance early while at the same time minimizing the interest paid over the life of the loans. Is it possible at all?
TIA
July 7th, 2009 at 1:56 pm
Yes, if the lower balance cards also carry the lower rate, then both methods are the same.
On the other hand, if you told me your highest rate was 12%, but you lowest was 10%, that difference may not add up to too much, or at least not the $4,000 in my example. Keep in mind, I used numbers that favored my position. But I also acknowledge that there are situations where it may make little difference. Dave is firmly ground in his own view, and no other.
July 7th, 2009 at 11:14 pm
nice analysis, great point of views…the graphs, everything is good
July 8th, 2009 at 5:01 am
[...] JoeTaxpayer wrote about the Dave Ramsey debt snowball and some issues with it. His post was inspired by my post on the topic which is pretty cool (although I think he would [...]
July 8th, 2009 at 10:45 am
Nice analysis! You’re right, though, the HUGE disparity between your highest rate and your lowest rate are what made the difference.
While I was paying down debt, I researched both methods and the difference was a mere $200 or so over the span of two or three years. It seemed a wash — though my rates were all in the vicinity of 9-15% or so…
Oh, and that calculator is the best I’ve ever found… Thanks!
July 8th, 2009 at 12:16 pm
No doubt, but I am a numbers guy, scientific method. It only takes one example of this kind to prove that Dave’s “never” is simply wrong. You are right, if the rip-off rate were only 14.9%, say, the difference drops to less than $400. And I’ll say “if you feel better dropping the number of bills you get, that’s ok by me, just understand, it will cost you $400 extra to do that.”
What’s so wrong with that?
BTW – My HELOC rate is 2.5%, and I actually have cards I pay in full whose rate would be 24%, so is that high/low spread so unreasonable?
July 11th, 2009 at 9:51 am
[...] – Thinking about Dave Ramseylrgche – Time to Refinance?mbhunter – Count the cost, both present and futurefreefrombroke – A Goal [...]
August 5th, 2009 at 4:48 pm
What if Dave Ramsey produced a study showing that, on average, his approach is more effective at reducing personal debt for the masses than your approach? Is he still “wrong” in your eyes? Is his approach still lacking in both numbers and science?
August 5th, 2009 at 4:58 pm
(Good to see you here, Elle!) Let me be clear, Dave’s method may very well be right for 90% of the people. My issue is with his position of dismissing the high rate payment method as myth or incorrect. I continue to say things like “do the math and determine what each method will cost you,” if the difference is minimal, by all means use Dave’s method. But my example while contrived is likely not so uncommon. I found that banks that gave me the best rates also gave the lowest credit limits, so I had a dozen cards at 12% with low lines, but one nasty high balance at 20%. I am open to the idea that feelings can and do come into play, often talking about a portfolio that lets you sleep, it’s Dave that appears to be completely closed minded, dismissing the financially superior method.
August 11th, 2009 at 9:32 am
Hi Joe. I would say we need to consider Mr. Ramsey’s audience vs. your audience. Ramsey is sort of a populist, appealing perhaps especially to those with a certain religious bent and maybe not all that much post high school education. Some 73% of the age-eligible population lack a bachelor’s degree. Ramsey has to do what he can with an arguably not-so-sharp, very likely overworked, population in very limited space. Assuming studies do show that the average consumer will pay his or her debt off most quickly by prioritizing by size of balance (rather than interest rate), I would not call him close-minded. I certainly think it is worthwhile to point out, as you have, that he is mistaken as a matter of financial numbers. But he is not necessarily mistaken as a matter of “the best solution” for getting the masses to pay down debt, using as justification those other numbers towards which I feel it is unscientific(!) of you to pay short shrift
. I will not knock Mr. Ramsey or Ms. Suze Orman or anyone, per se, who ultimately is getting people to pay down debt, especially when so many sharks, and even our government on certain fronts, is urging people to take on more debt.
As far as the difference in the two approaches possibly being miniscule, I would say that your approach promotes more careful thinking about budgeting in general. Watching a dollar here and a dollar there does add up. Besides, even if we are only talking on the order of $20 saved over a year using your method, $20 is still a nice lunch out in many towns.
Hats off to both Dave and you for helping people master their own destiny.
August 11th, 2009 at 12:40 pm
I thought my conceding to the 90% (above comment) showed my consideration for his audience, no?
I am trying to be open to the ‘feeling’ nature of financial matters. I don’t know how we can get any data to prove either side of this issue. Is there really a way to find those who are part of Dave’s demographic but chose the high interest method? I can cite numbers all day long, but of course numbers don’t equal success, I know that.
So really, what I am left with is to suggest when I am confronted with the debt snowball is to offer the spreadsheet on line and tell a reader that with their numbers entered they can see the difference in methods. If they are a “squeeze out the last nickel” guy, they may jump on the high rate method. If the idea of knocking off cards regardless of rate/balance, by all means use the snowball. Better?
August 12th, 2009 at 6:52 am
In my opinion, and speaking as a retired engineer and so fellow problem solver, characterizing Ramsey’s approach as being about the “‘feeling’ nature of financial matters” is unfair. I think it should be conceded that Ramsey’s debt reduction approach may be as much about numbers and science as your approach. I do not expect you to take psychology (which I think has plenty of science) into account with your financial planning solutions. But when others do, I won’t dismiss it as non-science and non-numbers.
Two cents (maybe from someone who one way or another has worked a little more with the masses? I would bet money that the overwhelming majority of those reading and participating here are four-year college educated, and so you are writing for a much more literate audience than the nation at large.)
August 12th, 2009 at 8:23 am
Elle, your visits and comments will always be appreciated. On this topic, I hope we can simply agree to disagree.