WAIT! DON”T GO! I promise, this will be better than 99% of the other debt posts on the interwebz. Yeah, that’s right, I intentionally misspell words since I’m so bad-ass. The incorrect use of the letters ‘x’ and ‘z’ is a prerequisite for being bad-ass.
Back when I wrote that post on whether personal finance bloggers have ran out of crap to say, I made an offhand comment about the “laughingly bad debt advice of Dave Ramsey.” A few people in the comment section wondered what the hell I was talking about, which probably happens all the time now that I think about it. Whatever. I’m lazy.
Dave Ramsey has this thing called the debt snowball. In case you’re a former Amish and have never heard of it, let me sum it up in a few sentences. If you’re already familiar, skip to the next paragraph. The debt snowball says that you should pay off your smallest debt first, focusing all your efforts on it. Once that’s paid off, you move onto the next smallest one, and so forth. Interest rates are not important in the discussion of the debt snowball.
HA! FOOLED YOU! This paragraph is also about debt snowballness. Let’s assume Moron #1 has the following debts:
Credit Card: $15,000 (18%)
Student Loan: $4,000 (3.5%)
Best Buy Loan: $1000 (0%)
SHAME ON YOU Moron #1… For shopping at Best Buy. Who even does that anymore?
If you followed the Ramsey doctrine, you’d be plunking all your cash on that Best Buy loan, even though those guys are literally giving Moron #1 FREE MONEY. If it took you 4 months to pay off that Best Buy loan, it’d be at the expense of the credit card. Assume simple interest on the credit card (18%*15,000*4 months) and you’re losing $675 by paying down this 0% loan instead of the one charging much higher interest rates.
You don’t have to be a Mensa member to figure out how bad this debt repayment method is. Interest keeps on accumulating on the other debts, it doesn’t just magically take a holiday because you decided to get your crap together. Every month a person follows Ramsey’s advice can cost them hundreds of dollars, and increase the time it’ll take them to accomplish their debt repayment plan. But hey, at least he’s church approved.
I’ve said this before somewhere, but it bears repeating, unlike most of my Taylor Swift jokes. Debt is not a psychology problem. It is a math problem. Unless you’re Richie Rich, (aside: why doesn’t Richie Rich ever WEAR PANTS?) you only have a finite amount of cash you can throw at your debt. You can either use it effectively to make progress on the highest interest debt or you can squander it on debt that costs you very little to service.
I can already hear your complaints. Nelson doesn’t know anything about paying off debt. Nelson is a robot without human emotion. Nelson, your penis is much bigger than mine. Sorry, I can’t help you much on that last one, but let me offer a rebuttal to the first two.
Unless you’re digging out of some colossal student loan debt, I guarantee I’ve been in more debt than you. I’ve bought (and paid off) several rental houses. I borrow money to buy assets regularly, and I’ve repaid that money. I’ve even juggled more than one loan at once. Guess what? Every single time I paid off the loan with the highest interest rate first. I did it because I did the math and the math told me to.
If I had to pick my single most hated phrase in the whole PF-o-sphere, it would be “works for me.” I hate that phrase more than Taco Bell hates actual food. It’s been used to justify bad financial decisions since 1837, and I’m tired of it. Whenever you find yourself uttering those words, know that you’ve made the wrong decision and that’s the way you’re justifying it.
You’re paying off two loans at equal pace even though one carries a 5.8% interest rate and the other one carries a 3.2% rate? No, that doesn’t work for you. It doesn’t work for anyone. It’s a poor decision. If it does work for you, it works crapily, kind of like that time I decided to use crapily in a sentence. I recently read about a guy who’s decided to save up the $15k he needs to pay off his student loan and then pay the thing off. But… But… But… That’s just so dumb.
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Sorry, I blacked out there and passed out on my keyboard. I may have had a small stroke. Where were we?
You’re all smart people. I bet some of you even have a 100 IQ. FINALLY, AN IQ JOKE ON FINANCIAL UPROAR. Can you stop letting psychology get in the way of these decisions? Debt should be looked at logically, and tackled logically. Yeah, I know it sucks to look at huge negative numbers. I’ve been there, and it’s not pleasant. But if you let feelings get in the way, that’s only going to increase the amount of time you stay in debt and the amount of interest you’re going to pay. Feelings have never been good for anyone, which is why I try to ignore mine.
And please, stop saying something works for you when anyone with a brain and 6th grade math skills can figure out that you’re paying too much interest. It’s the financial equivalent of turning on your oven to make toast.
More Boobs – less math.
But if it was illogical decisions that get you into debt, then clearly you should pay of debt illogically. The alternative, acting logically, is not a choice, apparently.
The other thing that kills me about debt repayment is when people have consumer/student loan debt, and they insist on investing. Instead of paying off their debt, which is a 100% risk-free return of i% p.a., they gamble on the markets (typically during the period of their lives when they know the least possible about them); because they use leverage, they don’t only face the risk of losing money, they face the risk of losing money that they also need to pay back. When people point out the 2 or 3% return difference, it’s complete bullshit. The gap in risk (risk free versus LEVERAGED+MARKET risk) makes it straight-up dumb. Pay off your CONSUMER debts (when did car loans and student loans become NOT consumer debts!? Student debts are even worse cause you can’t discharge them thru bankruptcy). Once you’ve built up some assets, use lower-risk leverage e.g. real estate (although not in Canada’s current bubble) or the Smith Manoeuvre (dividend stocks; this moves leverage from your home to the market at a slower rate).
Unfortunately, the sort of people who need to be told how to pay off the debt are already the people who have failed to grasp basic financial principles sufficiently to not get into the debt in the first place, and don’t have enough of a brain to figure out how to get out of it themselves.
Their brains simply don’t work the same way (or at all?) Logic will get you nowhere. As a hard left-brainer (the theory, not the undifferentiated reality), I’ve wanted to pull out my own hair trying to reach these people. Sadly, a large amount of the population runs solely on unadulterated emotion, and logic cannot penetrate the cloud.
Well said! I wrote about this just a few months ago. I don’t understand why money management can’t just be about the math. Emotions shouldn’t be a part of it, just do the math and start making payments. Clearly what you’re saying makes the most sense, but for some reason it’s impossible for a significant portion of the population to grasp.
Ignoring the psychological side of people and dealing only with logic and facts means you are not crossing the threshold of usefulness. If you do not address the psyche, you will not affect behavior. And if you don’t care whether something works but only whether you agree, then you will attract only people who are already like you and won’t really be changing the world at all. Poor Spock. Only very late in life did he ever understand that so much of human behavior is not logic driven…