Yes, Dave Ramsey is absolutely right in suggesting that more Americans should eliminate debt from their lives. But all of it? My answer is emphatically, no!
I believe there are two types of debt:“good debt” and “bad debt.” One can help us make money and build wealth, while the other can destroy us financially, or at the very least hold us back from reaching our full financial potential and enjoying life.
That’s why I believe we may need to enter into some degree of good debt in order to build wealth while staying out of bad debt. Yes, I know Dave Ramsey would call me crazy, but he’s not all-knowing and omnipotent. Allow me to explain my point of view, which certainly includes a Debt Snowball and so much more!
Step 1: Build an Emergency Fund While Making Your Minimum Payments
Don’t make your financial situation worse by missing required payments on your credit cards. We’ll get to the Debt Snowball in Step 2, but for right now, make your required payments while you start building an emergency fund.
The number one reason people get into credit card debt, or justify using it, is because of unforeseen emergencies. I give Dave Ramsey full credit for bringing this procedure to the forefront for millions of Americans. He talks about building your emergency fund because life happens, and oftentimes, that’s what ends up on those credit cards.
You need an emergency fund. Start with $1,000, $5,000, or whatever makes sense based on your financial situation. It could be as low as $500 when you’re just getting started, but have something set aside so when life hits you, you can go to your emergency fund rather than right back onto your credit cards.
Again, make your required payments and start building that buffer between you and using those cards again.
Step 2: Start a Debt Snowball
This comes after you’ve started creating that emergency cushion. Now, this isn’t a program you need to pay for or something expensive to implement. You can track it yourself with a simple spreadsheet or budgeting tool.
If you’ve never heard of this concept before, a “Debt Snowball” begins by making a list of your debts, balances, and minimum payments. Then you focus additional payments on the debt with the lowest balance. Once that debt is gone, you take the money you were paying toward it and roll it into the next debt. The payment gets bigger and bigger as you knock out each balance. That’s the “snowball.”
There are other approaches to paying off debt, including prioritizing the highest-interest debt first. What matters most is having a specific plan, sticking to it, and getting that bad debt out of your life.
Bottom line, get your snowball going once you have that initial emergency fund in place.
Step 3: Start Creating New Revenue
This is where Dave Ramsey and I start to differ in the debt management process. It’s a lot harder to dig yourself out of a hole if all you have is a fixed income.
Some of you have a great day job you love. You’ve gone to school for years to get there and you’ve been trained to be an expert, but now all you have is a W-2 with a “glass ceiling.” You’ve got to break through that ceiling! How do you do this? I don’t want you to quit your job. I want you to consider building a small business on the side and using that additional revenue to get out of debt faster.
Once you’re out of bad debt, you can use that additional income, along with the cash flow freed up from the debt you eliminated, to start building more wealth for the future. This process can help you stay out of bad debt rather than simply paying it off and ending up right back where you started.
Now, this small business could be selling products online, consulting, freelancing, providing a service on evenings or weekends, or turning a skill you already have into additional income. I don’t care! Most importantly, find something that makes sense for you and that you can realistically build.
I love small business, and you’ve got to develop this aspect of your financial life. It can bless you for many years to come.
Step 4: Don’t Automatically Cut Up Your Credit Cards
Now that you’re getting out of bad debt, don’t assume you necessarily need to close every credit card account.
Your credit history, payment history, amounts owed, available credit, and other factors can affect your credit score. Closing an established credit account can sometimes affect your credit profile, so think strategically before automatically closing everything. The bigger issue is whether you can use credit responsibly.
If keeping a card open is going to tempt you right back into debt, that’s a different conversation. But if you can keep your balances under control, pay your bills on time, and avoid carrying expensive consumer debt, an established credit history can be valuable.
And when someone at a department store asks whether you want to open another account just to save a few dollars on today’s purchase, you can simply say, “No, I have my credit cards in order.”
Step 5: Go Into Debt
You heard me right right. But I’m talking about good debt.
I want you to understand how debt can be used strategically to buy rental real estate, start or expand a business, acquire productive assets, and potentially build additional cash flow.
This does NOT mean every business loan, mortgage, or investment loan is automatically good debt. The numbers still have to work. Taking on debt for a terrible investment doesn’t magically make it good because you called it “productive.” But there is an enormous difference between borrowing money to fund a lifestyle you can’t afford and responsibly using leverage to acquire an asset or grow a profitable business.
The Bottom Line
My recommendation is simple. Get out of bad debt, build your reserves, and learn how to use good debt strategically to create assets, opportunities, and additional cash flow. Getting out of bad debt is important. Staying out of bad debt while building wealth is even better. And as you work to free up more cash flow, don’t overlook one of the biggest expenses in your life: taxes.
Find a trusted advisor through the Main Street Tax Advisor Network. Every advisor in the network has been trained by me to speak my language and understand proactive tax planning. They can help you identify legitimate strategies to reduce your tax bill, keep more of what you earn, and put those savings toward paying down debt and building wealth. Every extra dollar you stop unnecessarily sending to the IRS is another dollar you can put to work improving your financial future.
