What are Dave Ramsey’s Baby Steps?

With reports that outstanding credit card debt in 2017 has reached record levels, it seems that American consumers have already forgotten the lessons learned from the financial crisis nearly a decade ago. Today, more than 170 million consumers have access to credit with nearly 70 million carrying unpaid credit card balances which threatens their financial future. Getting out of debt has proven so challenging for many consumers that an entire industry has been built around the “get out of debt” mantra. The face of that industry is a Tennessee businessman who once owed more than $2 million before filing for bankruptcy.

Over the last 25 years, Dave Ramsey has built a small empire around teaching and counseling people about the ravages of debt and how to live a debt free life. In addition to writing several bestselling books, Dave is a nationally syndicated radio host, TV personality, and founder of Financial Peace University, a non-profit organization that conducts workshops and seminars on college campuses throughout the country.

Dave applies his principles for handling personal finance challenges in a direct, tough-love approach which he distilled down to a seven-step plan for getting out of debt called the “7 Baby Steps to Financial Peace.” Thousands of his radio listeners and workshop attendees have completed or are in process of completing the 7 Baby Steps, which is a challenging but doable program for people who are ready to change their habits. For most people it is the discipline required that trips them up, but that is why Dave structured the plan as baby steps, allowing followers to take small but key steps so they can achieve victories along the way.

Dave has written an entire book and curriculum on the baby steps; but sometimes it helps to get a brief overview of how they work and where they lead to help people see the big picture and visualize themselves successfully completing them.

Dave Ramsey’s 7 Baby Steps

Baby Step 1: Save $1,000 in an Emergency Fund

You have to look no further than the fact that nearly 70 percent of Americans have less than $1,000 in savings to know how much of challenge this is. But, the real challenge is in the mind of the consumer who thinks they have something better to do with their money than to put it in savings. So when an unexpected event occurs – the loss of a job, a major car or home repair, an unexpected pregnancy, or any number of what Dave calls, “Murphies” – they must go further into debt to cover the expense. This is the vicious cycle of debt people have to break before they can move on. Anyone can find an extra $50 or $100 in their budget each month to put towards a “starter emergency fund.” Once it’s there, there is no need for credit cards or borrowing from the Bank of Mom and Dad. An important key is to replenish the fund each time you have to dip into it. There should always be at least $1,000 in the emergency fund.

Baby Step 2: Pay Off All Non-Mortgage Debt Using the Debt Snowball

There are two popular methods of paying down debt quickly – the Debt Avalanche and the Debt Snowball. The Debt Avalanche method is considered the quicker of the two because it involves paying off the debt with the highest interest rate first. However, Dave espouses the Debt Snowball method, which involves paying off debts with the smallest balance first. His rationale is that it requires an immense amount of discipline and motivation to stick with a debt payoff plan. By tackling the smallest debt first you can more quickly rack up small victories. This, he says, is the key to staying motivated.

With all your debts listed, from smallest to largest, you start out making the minimum payment on all debts and then apply any excess cash flow toward the smallest debt until you pay it off. You then take the minimum payment you were paying on that debt and apply it to the next biggest debt along with your excess cash flow until that debt is gone. With each debt payoff you have additional funds to apply to the next biggest debt, hence the “snowball effect.” Each time you are able to stamp a debt as “Paid in Full,” your motivation grows as does your confidence in achieving the ultimate victory.

Baby Step 3: Accumulate 3 to 6 Months of Expenses in Savings

The $1,000 emergency fund was just a starter fund. Your real emergency fund should contain at least three to six months of living expenses to act as a buffer against unexpected expenses. For a household that spends $3,000 a month on living needs, they need $9,000 to $18,000 in their emergency fund. Having completed Baby Step 2, all the funds you were using to pay off your debt can now be applied to building your emergency fund.

Baby Step 4: Invest 15 Percent of Household Income into Roth IRAs and Tax Qualified Retirement Plans

With your debt paid off and your emergency funds fully funded, it’s time to focus on securing your retirement by maximizing your retirement savings. Dave suggests a target of 15 percent of your income to be contributed to tax qualified retirement accounts, including your 401(k) plan or, if you don’t have one, a Roth IRA. This can be accomplished more easily when you’re able to set up automatic contributions to your plan. If you’re unable to invest 15 percent of your income right away, set a goal of increasing your contributions by one percentage point a year. Your maximum contribution should not exceed 15 percent because you will need any excess cash flow to apply to the next part of Dave Ramsey’s baby steps.

Baby Step 5: Funding College for Children

Dave is adamant that you should not save for your children’s college until you are able to secure your retirement. You shouldn’t start saving for college if it will reduce your retirement contributions. If you have excess funds to apply to college savings, you should first consider the cost-benefit of sending your child to college and how much you really expect to spend on their college education. If you can comfortably set aside money for your children’s college education, you need to fully explore your college savings options. Dave recommends you only use tax-qualified plans such as Education Savings Accounts (ESAs) and 529 plans.

Baby Step 6: Pay Off Your Mortgage Early

With your retirement and college savings locked in, Dave wants you to turn your attention to paying off your mortgage as soon as possible. It’s not all about saving tens of thousands of dollars in interest costs, although that will give a big boost to your wealth. It’s more about cash flow and what you can do when you have more of it around. The next step is about building wealth and the best way to do that is by investing all your excess cash flow. Plus, Dave insists that carrying a mortgage payment into retirement is one of the worst things you can do.

Baby Step 7: Build Wealth and Give a Bunch Away

Many of the wealthiest people got that way by living debt free and below their means. That is essentially what you will be doing when you reach Baby Step 7. With no debt payments and your savings habits well-entrenched, everything you do from this point forward is about building your wealth. It means developing a long-term investment strategy that fits your investment and risk profile, and having the patience and discipline to stick with it. However, to achieve true financial peace, as is the objective of the program, Dave believes one should show their gratitude by giving to others in need. True wealth is not about having money; it’s about having the greatest impact on the people and the community around you.