Baby Step 2 - Getting out of Debt

In my last column I discussed step 1 of Dave Ramsey's Seven Baby Steps (see http://www.daveramsey.com/new/baby-steps/). The baby steps are as follows: (1) save $1000 to start an emergency fund, (2) pay off all debt using the debt snowball (besides your home), (3) 3 to 6 months of expenses in savings, (4) invest 15% of household income into RRSPs, (5) college funding for children, (6) pay off home early, and (7) build wealth and give.

This week I will discuss getting out of debt (besides your home). Some people are deep in debt with no readily apparent way out. Some have debt but plenty of assets that could be used to pay off debt. Many are somewhere in between, but it's these two scenarios that I would like to discuss.

First, to those who have debt and the means to pay it off, I would say write a check today and get rid of it, even if you have to sell assets. If you think you can borrow money at a low rate and invest at a higher rate, you’re probably forgetting about risk and taxes. For most people taxes alone will eat up at least one-third of gains. Risk can be a topic for another column, but suffice to say that, in general, the difference in return between different investments is due to a difference in risk (the higher the return, the greater the risk).

Second, to those who are deeply in debt and see little hope, I would say the key to gaining hope is having a plan. The snowball method for getting out of debt is simple and effective. The plan is to put all of your extra money toward your smallest debt, pay it off, and then work your way to your largest debt. In most cases ignore interest rates because the psychological effect of gaining momentum as you pay off debts is more important than saving a little bit of interest.

The key to this step is FOCUS and INTENSITY. Take care of your most basic needs of food, shelter, clothing, and transportation, and then pour everything else into your debts. Sell stuff, take an extra job, stay away from restaurants, cancel cable, eat inexpensive food, and take inexpensive vacations, if any at all. It will be tough, but the sacrifice will be worth it when you can pay cash for things without any associated stress. Once you sit down and write out your plan you will be very surprised at how quickly you can get out of debt. A family with an average amount of debt and average income can be completely debt free within 18-24 months!

If you have any questions about debt or anything else related to personal finance, please email me