Where Dave Ramsey's Debt Snowball Fails
I’ve written extensively about how Dave Ramsey’s “Debt Snowball” does a disservice to families and individuals struggling to get out of debt. By acquiescing to the emotions of money, those who most need to separate emotions from their financial decisions don’t. Not everyone who is in debt are in that position due to emotionally-driven decision making, but many are. When you look at total time spent getting out of debt and total cost, making the choice to take a less emotionally-driven approach to getting out of debt is better. No decision is never fully logical because we are human, but the ability to recognize the pull of emotional decision-making is necessary for improving financial decisions in the future. And in some cases, people just aren’t aware that the Debt Snowball method is potentially more expensive and more time-consuming than other options.Banking Deal: Earn 1.40% APY on an FDIC-insured money market account at CIT Bank.
A reader encountered a different problem when applying the Debt Snowball method. Here is her experience, slightly edited:
A few years ago I found myself in $27,000 of credit card debt. I heard about the Ramsey Debt Snowball method and liked it, so I tried it out. It worked well, and I paid down one of my three credit cards quick! Then I got a letter from the second credit card. They were not happy simply receiving the minimum payment while I was paying down the first, and they considered me a “risk” because of that, so they bumped my interest rate from 9% to 18%. WOW! I was shocked!
I started my own way to pay down my debt: the transfer method! I transferred all my debt to the lowest interest card, that was 5%. Then a few months later, I started hunting down 0% interest cards. When I found one that had at least a term of twelve months, I transferred a portion of the balance on the 5% card to the new 0% card that I could pay off in twelve months. Then when that was paid, I’d hunt again, and transfer out another portion I could pay off during the 0% promotional period offered.
What this reader experienced could happen to anybody, regardless of the debt payoff method. It could happen even if you’re using the mathematically superior Debt Avalanche or if you’ve created your own hybrid method. Despite the new regulations as a result of the Credit CARD Act of 2009, credit card companies can still change your interest rates in limited circumstances. The reader must have run afoul of one of the few situations in which issuers are allowed to raise interest rates on existing balances.
Using credit cards that offer a limited-time 0% APR on balance transfers is one way to immediately reduce the amount of interest you’ll pay over time. Even with a balance transfer fee of 3%, you could save money if you play by the credit card’s rules. You’ll also need to consider the impact of opening a new line of credit; if you’re looking to buy a new house soon, a new credit inquiry and account could temporarily lower your credit score, forcing you to qualify for a higher interest rate on a mortgage.
If that type of consequence is not important to you, you can save interest costs by finding the right credit card introductory deals for as long as you need to pay off your full balance. If you don’t pay off or transfer a balance under a 0% APR program by the deadline however, the issuer will likely charge you their regular interest rate, even on the balance you had paid off until that point. It’s a sneaky trap, especially when combined with a credit card issuer that doesn’t reliably send out statements.
Keep your eyes open if you plan on playing the 0% APR balance transfer game. Although it was related to 0% APR on purchases, not balance transfers, problem many years ago with a credit card company that penalized me with back interest after not sending me statements.
The reader continued, offering tips for other readers hoping to take advantage of 0% APR balance transfer offers to pay off debt:
Now with this method you definitely must make sure that you make your payments on time, and be sure that you can pay off any amount you transfer during the 0% promotional period. Also, take into consideration the fee for transfer, which usually is around 3% of the balance. I have been doing this for a few years and I am proud to say that I am down to my last 3 payments (balance of $2900 at 0% interest), and have managed to save $10,000 in a liquid savings account. I hit these payments with $1,000 a month.
It took lots of discipline, so if it is important to you, look through all of your bills and see what you can cut out. I have a basic home land line (just a dial tone and basic internet), no cable, just basic cell phone with texting (no web or data). I use coupons avidly, eat out rarely, and buy clothing on clearance or shop at thrifts. I also do some hobby work on the side that covers my gas expenses and kids lunches for school. This has worked for me and my family, and being a single mom, I think I have done pretty darn well! The sacrifice has paid off. Beware of that Ramsey Debt Snowball. You might get one slammed right in your face like I did!
Again, this circumstance could happen with any debt repayment plan — not just the Debt Snowball. Remember to read all the statements that come from the credit card issuers so you don’t miss an important notice like an interest rate change. Any changes would require you to re-evaluate your plan for paying off debt.