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Debt-snowball method...is it really the most effective way to payoff debt?

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Education & Training with Independent Leadership & Financial Fitness Consultant

My partner and I have been discussing a number of seminars that we can offer our clients.  We want to provide an overall financial package that includes everything, from buying your first home, to planning retirement.  One problem we've noticed that throw most people off track is debt.  The one basic problem for most home owners is that there is not enough coming in each month, and too much is going out of pocket.  Therefore the need to use credit is over whelming, and as national numbers prove, the problem isn't getting any better.

The other night I was listening to Dave Ramsey on the radio.  The guy seems pretty common sense, plus he has an awesome radio voice. Anyway, I kept hearing his callers talk about the Debt-snowball.  I figured it was some type of debt payoff program, and after pulling it up on wikiepedia ( debt snowball )

Basically you take all your debts, from the smallest balance to the greatest balance.  You then commit to make the minimum payment on each of the debts.  You then take any extra money that you normally would put down on your car or home, and apply that to the smallest balance.  The theory works because as you pay off each balance, the minimum payments roll to the next balance, and the money that you use to pay down the debts begins to snowball.

Their are a few disadvantages to this program.  The biggest is that Ramsey suggests you forestall your retirement plans by two years.  In other words, you need to stop funding any retirement accounts and makes sure those extra payments are going towards the bills. You can make up the lost time after two years, because then you can put allot more into your retirement accounts at that point because you have zero debt.

This theory wouldn't be horrible in concept, but many of us have matching employer 401k accounts, and two years is still two years of your money not working for you. Dave may have a case for most people, but everyones financial fingerprint is different, and there maybe some other way's to rid oneself of the debt and still continue funding retirement.

The big problem with debt is it is normally a symptom of the lack of cash flow.  Businesses will deal with this problem several ways, most will reduce costs, some will finance the debt into a long term mortgage, thereby reducing the outflow. The one problem with reducing costs, is that you tend to avoid risk.  If you avoid risk you tend to miss opportunity, which exacerbates the real problem, the lack of sufficient cash flow.  

So the real solution maybe more complicated than simply conducting your own debt-snowball.  I would ask yourself several questions, such as, "Is my income going to increase or decrease during the next two years?".  Your age is pretty important as well, what type of job you have, where you live, the cost of housing, how much equity you have in your house?  All these questions are important and can influence your plan either way.

I'm a strong advocate that the average person should treat their personal finances like they'd treat a business. In other words you need to do everything you can to maximize opportunity and cash flow, while planning for your eventual retirement. 

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Comments (1)

Mehmet Met Dilsiz
FND Photography / M2 Real Estate Solutions - Midvale, UT
Great info Karl,  it is featured now...
Oct 29, 2007 07:22 AM