The Hell With You Dave Ramsey! I’m Paying My Highest Interest Debt First!

Whoa, this is a huge statement in this Monday morning! What am I thinking; attacking of the most popular personal finance guru; Dave Ramsey? Who am I to critic his way to pay off debts? Well, I’m simply a guy that don’t think the same way

While surfing Dave Ramsey website and listening to his Ramsey Radio Show, I found the “myths of personal finance” (this is at the bottom of his website). This is where Dave Ramsey provides a group of myths about personal finance and how things should be done according to the “Ramsey way of paying off debts and managing personal finance”.

While I agree with most of his advices, I got somewhat confused about the following myth and his answers about it:

Myth: “You should pay high interest debt first”

Dave Ramsey’s answer: “You should pay the smallest debt first in order to create a momentum”.

Then, he mentioned that, according to his own experience, most people can’t pay off their debts because they don’t have the right mindset and not because they don’t have enough cash flow.

I somewhat agree with this statement as you really need to get out of debts before you can actually pay a dime on your credit card efficiently. The very first thing to do in this situation is to write down a plan of action and keep track of it.

Where I disagree with Dave Ramsey is that you can build momentum by looking at how much interest you save every month by focusing on the highest interest rate debt! If you have a credit card of $10,000 at 15%, you are better off paying is and forget about your $1,000 small credit card at 8%. If you see the 10K debt as a huge mountain you can’t climb, Dave Ramsey suggests that you forget about the mountain and that you start with the small hill (1K debt).

I think you are better off calculating how much you would pay in interest over your 10K debts if you take a year to pay off your small debt. You would probably save roughly $100 of interest every year by paying down your 10K debt. That’s probably an extra monthly payment for free! I don’t know about you, but that motivates me to pay off my highest interest debt first… sorry Mr. Ramsey

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CTB on March 23, 2009 | Filed Under Consolidation, Pay off debts

9 Comments

Silver Rose on March 28th, 2009

I found your article while Stumbling.

I totally agree that you should pay the highest interest debt first. Sometimes the interest is so high that it cancels out whatever you pay to your smaller debts - and you are no further. It’s getting the interest payments down that is key to getting out of debt.

Matt Jabs on March 28th, 2009

People who do NOT need momentum to help them stick to the debt repayment plan should indeed pay off the highest interest amounts first.

People who DO need momentum to help them stick to the plan should definitely pay of the smallest debts in succession.

There is no one proper way for everyone. Both of these methods make sense for different types of people.

DebtFREEk!

Praveen Puri on March 29th, 2009

I’ve seen this topic come up before. Most people advocate paying off your debts, but then disagree about the payoff order. Should you first pay off the debt with the highest interest rate, or the one with the lowest balance?

I agree with Ramsey, because paying the lowest balances first taps into psychology and motivation.

Sure, those of us who already have good financial habits could save an extra $100 by paying the higher interest rates first.

But the people that Ramsey is trying to help, who are trying to break the spending/debt trap, would lose more if they did not stick with paying off the debt.

Focusing on the lowest debt first increases their chances of success, because it generates the instant gratification they need to build confidence and feel motivated to spend less, and make paying off their debt a habit.

Also, I think that in the real world, our lower balanced debts tend to be the ones at the higher interest rates.

For example, the spectrum of pay day loans - credit cards - car loans - mortgages tend to go from the highest rates to the lowest, because their is more collateral and less risk as you climb the spectrum.

But, that same spectrum also runs from lowest to highest balance.

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Beyond Paycheck to Paycheck on April 6th, 2009

Reasonable people can disagree.

For what it’s worth, I’m with you. I buy the importance of momentum and think seeing your success is an important part of continuing to achieve it. Still, I always teach people the right habits right away. I don’t believe that “beginners” should start with the wrong habits solely for motivation/momentum sake.

The truth is, financially speaking, there is a right answer and that is to pay down your highest interest debt first. But, like a previous commenter said, this isn’t strictly finance.

People who go out of their way to listen to folks dispensing PF advice are already somewhat motivated. They are beginning to exit the denial stage. I say “Tell them the best way to do something.”

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Martin on April 11th, 2009

You just have to be honest with yourself about what motivates you. If you know that you can be a robot over the many months or years that it will take to pay off your debts, then by all means, do the most mathematically advantageous method by paying the highest interest rate debts first.

Of course, the majority of people who got into significant amounts of credit card debt did so because of their behavior. Even though they understood how math worked, they still went into debt. So the key for most people is motivation and behavior modification, not math.

Quick reward is important to keep up the psychological advantage. For me, it helped a lot that I had one less bill to pay. One less bill is one less check to write (or one less online payment to make). The less checks you *have to* write each month, the more it feels like you are in control.

My mortgage has always been the highest interest rate debt that I have, because any credit card balance I had was on a low interest balance transfer rate. But I went with the Dave Ramsey method and paid the credit cards first. If you miss a payment on your credit cards, the rate will go up to 30% or higher even though it may currently be at a lower rate. With credit cards, every payment reduces your monthly expenses by about 2% of the payment as soon as you make it. With a mortgage, you have to pay the whole thing off before it has any effect on your cash flow.

I tend to think Dave is right for about 90% of people who carry significant balances on their credit cards. Assess your own psychology and behavior patterns, your own debt load, your own income, and make your own decision.

Flower on April 13th, 2009

The point is - pay the lowest debt first (the one you can get of fastest)regardless of interest rate, then, rather than spending the “freed up” amount, add it to the next lowest debt. Continue to roll each former payment into your next debt and you’ll be out of debt years sooner. You haven’t had the use of that money anyway so you won’t miss it. Example: if you’re paying a total of $2,000 in debt payments today, then use that entire $2,000 to pay off your debts until you are entirely debt free. Should take 3-5 years to get out credit card debt and another couple of years to get rid of your 30-year mortgage (if you have one). Now invest your $2,000 in mutual funds and you’ll be wealthy in the same amount of time it would have taken to pay off that 30-year mortage.