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If you have been searching around the personal finance world, you’ve probably seen or heard Dave Ramsey’s baby steps.
I was a late bloomer, I discovered Dave Ramsey in my mid 30’s. However, I believe that it is better to start late than not to start at all. Our personal finance was a wreck before we knew of Dave-I did not even know what budgeting is. It was a shame, but I know better now.
If you are tired of how your personal finance life is going, and you are looking for proven financial plan guidance, you are in the right place.
But before we dive in, who is Dave Ramsey?
Dave Ramsey is a well-known finance guru who helps people like you and me achieve financial freedom. His principles came from his own experiences in the financial world. His inspiring life story includes the time when he was very wealthy, to the time when he became broke. And how he worked his way back up again.
The lessons he learned from his battle against bankruptcy was turned into a program called Financial Peace University. The Financial Peace University until now continues to help millions of people be financially free.
I think that is enough proof for us, who are seeking financial independence to listen to him.
I first discovered Dave when I stumbled upon his budgeting app call the Everydollar App. The app helped me a lot that it made look deeper into the person who founded it–Dave Ramsey.
After learning more about him, I bought his book The Total Money Makeover: A Proven Plan for Financial Fitness and devoured it in a week. It was an easy read but it was so jampacked with many life-changing lessons.
In the book, Dave shared his seven steps to financial freedom which he calls “7 Baby Steps”. I started applying these steps in our financial independence journey and it quickly changed our lives for the better.
In this post, you will learn about Dave Ramsey’s baby steps. Also with some tips on how we incorporated these steps into our own personal finance lives.
What is the “7 Baby Steps”?
The “7 Baby Steps” is the proven formula introduced by Dave Ramsey to take control of your finances. These steps are easy to follow that you do not need a degree in finance to be able to do it.
It is also a step by step formula, therefore, you need to follow the steps from the beginning to the end, no skipping ahead.
Who is this formula best for?
The “7 Baby Steps” is perfect for those who are seeking a proven guide to financial independence at any stage in their lives.
Benefits of Dave Ramsey’s Baby Steps
When you follow Dave Ramsey’s baby steps, you will be confident that you are following a proven plan. Since it is a step by step guide, you will not get lost along the way.
When you complete the Dave Ramsey’s baby steps, you will be financially free. Can you imagine a life with no debt payment? You will be able to really enjoy your life–money-stress free.
What Are Dave Ramsey’s 7 Baby Steps
#1 Save Your First $1000 of Your Emergency Fund
The first on Dave Ramsey’s baby steps is save $1000 for an emergency fund. Emergency Fund is the amount of money set aside to take care of emergency expenses. These expenses can include sudden plumbing repairs, car problem, medical expenses, loss of job and etc.
According to CNBC, there are only 39% of Americans who can afford a $1000 emergency. And that is mind-blowing, 61% of Americans will not be able to afford a tire change emergency.
For an expense to be qualified as an emergency, it should be necessary, urgent and UNEXPECTED.
Therefore, you will only use your emergency fund if something happened out of the blue. And it has to be taken care of immediately.
It can be an unexpected medical cost, unexpected home repair or flat tire or expenses during a job loss.
In our case, we were lucky to have a little bit of savings. So I took out $1000 from there and put in a different account. I made sure that this account also earns interest.
However, not everyone is able to have $1000 immediately. Saving $1000 can take time for most. But there are ways you can do to set aside this amount of money. You can start by cutting down your expenses. Check out 101 Smartest Ways to Save Money.
You can also grow your income by doing these side hustles.
However, you might be wondering if you really need an emergency fund. Yes, definitely.
We cannot predict the future but we can definitely prepare for it. By having an emergency fund, you will be confident that you can take care of any surprises that will come knocking at your door.
Also by having an emergency fund, you will less likely add any to your debt.
#2 Ditch All Your Debts Except Your Mortgage
The second on Dave Ramsey’s baby steps is debt payment. Once you saved your $1000 in an emergency fund, it’s time to take care of your debts. Your goal in this step is to pay off all the debt that you have except your mortgage.
These debts can include borrowed money from friends and families, credit card debt, student loan, personal loan, car loan and etc.
How to pay off debts?
Know how much you owe.
To succeed in a battle, you have to be aware of how big or small your opponent. By being armed with knowledge, you will be able to plan out a better attack.
So in this case, you have to know the total of your debt. You can do this by gathering all your bank statements. And then start listing down all your current balance on each account. You will then add everything to come up with the total.
I use Personal Capital which makes it easy for me to track our saving and all our debts. It also keeps us updated on our net worth through its FREE Net Worth Calculator.
Stop Adding to Your debt
The first and most important thing you can do to pay off your debt is to stop adding to your debt. Stop borrowing money by swiping your credit cards.
Start using cash instead of your card when making purchases. Introduce yourself to the cash envelope system, which will help you avoid using your card when transacting a purchase.
Create A Budget
By having a budget you will be aware how much money is coming and going. By knowing how much money is actually coming in will make you more mindful about how much you are spending.
People get into debt because they are spending more than what they are actually making-also known as living beyond their means.
By having a budget, you will have more control over your money and will less likely live beyond your means.
You will start your monthly budget by listing down all of your total household income. The total will include earnings from your full-time job and other side hustles.
Next, you will list down all the expenses that you incur every month. You will need to figure out your expenses in the last 30 days. Personal Capital has a feature that tracks your expenses during the date range that you choose.
You can learn more about how to set up a budget by checking out Best Guide to A Monthly Budget for Beginners.
Set A Budget for Monthly Debt Payment
Once you have a monthly budget, you can now calculate how much money can go to your monthly debt payment.
You can determine your monthly debt payment by first listing down all your debts and their corresponding minimum payments. After that, you will add all the minimum payments. The result will be the amount that you have to at least come up with every month.
Choose the Best Strategy to Pay Off Your Debt
There are a lot of strategies to pay off debt out there, but I would recommend using the Debt Snowball method.
You can use the Debt Snowball method when you have multiple debts. This method involves paying off the debts from the lowest balance to the highest balance, regardless of interest.
I use this method because it motivates me to keep going to the next debt once I paid off one debt.
The concept behind this method is to continuously motivate you to stay on track on your debt payoff journey by giving you quick wins along the way.
To use this method, start by listing down all your debts and their corresponding minimum payments. Then rank them from the lowest balance to the highest balance.
You will then begin paying as much as you can on the debt with the lowest balance while paying the minimums on the other debts.
Once you finish the first debt, move to the second and so on. Learn how to use the debt snowball method by checking out Dave Ramsey’s Debt Snowball Simplified.
Consider Balance Transfers
I only recommend this method if you have a really great offer like 0% APR, 3% or less transfer fee and no annual fee. This is very important because balance transfers are not free.
You have to make sure that the total fee you will pay doing the balance transfer is less than what you will pay on interest if you are not doing a balance transfer.
If you want to learn more about how to use a balance transfer, check out Best Strategies to Pay Off 10K Credit Card Debt.
Negotiate Credit Card Interest Rate
If you do not have a good balance transfer offer, consider picking up the phone and calling the credit card company to negotiate for a lower interest rate.
The worst that they can say is no, but at least you tried.
Consolidate All Your Debts
Consolidating all your debts in order to have only one monthly payment can lower your debt. You will be able to secure a lower interest rate, therefore, saving you money.
However, you have to remember, you are still in debt, therefore pay it off as soon as you can. Also, choose a debt consolidation offer that does not penalize you if you pay off the debt earlier.
Pay More Than The Minimum
Every month, aim to pay off more than the minimum so that you will pay off your debt sooner.
You can work overtime or pick up some side hustles to earn extra money and use it for debt payment.
Track Your Progress
Now that you have a concrete action plan, you are now excited to start your debt payoff journey. You will be doing everything to meet your goal every month.
However, you will be needing motivations throughout your journey. And you can do this by tracking your progress.
By having visual tracker, you will be constantly reminded of how much you have accomplished and how much closer you are to your goals.
You can then look back into it when you feel unmotivated. This way will keep you focused and reminded on why you are working on this goal.
#3 Fully Fund Your Emergency Fund
A fully funded emergency fund is a pool of money saved that is equal to 3 to 6 months worth of expenses. So if your monthly expense is $5000/month then you should start saving to have $15K to $30K in you fully funded emergency fund.
Now that you have that much money, where should you keep it?
Although your emergency fund is not your savings, you should still keep it somewhere that will make you money, like a high-yielding savings account or put it on investment.
The most important thing to note is that wherever you decide to keep your funds, make sure you have the ability to withdraw the moment you need the money.
#3b Save for Downpayment Of A House
Now that you are all geared up and prepared when Murphy decides to knock on your door, it is time to save up for your forever home.
If you don’t know who Murphy is, he is the guy coined by Dave Ramsey referring to Murphy’s Law, which states, ”Anything that can go wrong will go wrong”. Hence having an emergency fund is a must.
According to Dave, aim for a house that will have a monthly mortgage of less than 25% of your household income. So if your monthly take-home pay is $4000, your monthly mortgage should not be above $1000.
Dave Ramsey strongly supports the idea of buying your home in cash, meaning you out 100% down. However, we all know that this is not possible for most Americans. In this case, he strongly suggests on his Baby Step 3b that you take out a 15-year fixed rate mortgage.
Furthermore, you should make sure your downpayment is between 10-20% to avoid PMI, also known as Private Mortgage Insurance.
So it is very important at this stage to figure out the price of the home that you wanted and start working on saving 10-20% for downpayment.
Another important thing to consider when shopping for home after you get your approval for a home loan is to look for homes that are less than what the bank is willing to pay. In this way, you will rest assured that you will not be using most of your monthly budget to pay for a mortgage.
When banks give you a pre-approved loan amount, this is the price of a house that you can afford based on their records. However, they are not aware of the other monthly expenses that you incur. Therefore, buying a home that is priced lesser than your pre-approved loan will give you room for other expenses.
We already bought our first home before we started the baby steps and I am proud to say that we did some things right. We chose a home that is lesser that we were approved for, we put down 20% and our monthly mortgage is not more than 25% of our monthly take-home income.
#4 Allocate 15% Of Your Household Income Into Retirement
Aging is something that we cannot prevent but it is something that we can prepare for. According to CNBC, most Americans are not saving enough to be able to retire by age 65. As a result, most Americans are still working past retirement.
If you are one of those whose goal is to retire and enjoy retirement, you have to start saving for retirement.
Number four on Dave Ramsey’s Baby Steps recommends that you should invest 15% of your household income into your retirement plan. So if your household income is $100,000/yr, $15,000 should be invested in retirement.
He also emphasized that you start your contribution where you are getting free money, and that is your 401K with employer match. If your employer matches 100% if you contribute 3%, then contribute 3% of your income.
After that, move on to get a Roth IRA and another for your wife, if you are married. The maximum contribution for Roth IRA in 2019 is $6000 and the catch-up limit for 50 and over is $1000.
So if you contribute 3% of your income to 401K, which is $1,500, and your wife contributes 3% to her 401K which is also $1,500 and then both of you put in $12,000 ($6000 each) into IRA, your total contribution will be $15,000. That is 15% of your total household income.
However, what if you came out under 15%. For example, after contributing to 401K and IRA, your total contribution is $12,000, that is only 12% of your household income. You will then increase your contribution to your 401K by 3% to have a total of 15%.
Although it does not have a match, you are still taking advantage of the pre-tax contribution.
Now that you have your contribution maxed out, you will now work on optimizing your investment. Dave Ramsey’s recommendation is to invest in good growth stock mutual funds.
With 401K, you will have a limited choice of mutual funds to choose from but with Roth IRA, you will have more flexibility. You will be able to diversify your portfolio.
Dave recommends having a balanced mix of mutual funds by having your investment equally allocated to Growth, Growth and Income, Aggressive Growth and International.
Yous should focus your investment on mutual funds that have a strong and solid track record for at least >5 years.
If you want to learn more about investing, check out Chris Hogan’s Everyday Millionaires: How Ordinary People Built Extraordinary Wealth―and How You Can Too.
Your retirement money will grow more the longer you have it invested because of compound interest.
#5 Start Saving For Your Children’s College Fund
A student loan is one of the highest debt that almost all Americans have. According to NBC, the total amount of student loan at the end of 2018 was $1.47 trillion.
Having a student loan is becoming to be a norm for every American. However, the stress that it causes is not even worth it. The sooner you pay it off, the happier you will become.
One of the thing that you can do to prevent student loan stress to cripple your kids later in life is to prepare for their college education. Preparing for their education means saving for a college fund.
There are three plans that Dave Ramsey recommends for those who are looking for the best plan for their kids.
3 Tax-Favored College Fund Plans
The 529 plan is a tax-advantaged plan that is sponsored by the state. There are types of 529 plans but Dave Ramsey recommends that you should use the plan that lets you choose your investments.
The good thing about the 529 plan, aside from being tax-free growth, is that you can have higher contributions. Also, you have the ability to change the beneficiary, from one kid to the other.
Education Savings Account (ESA)
Another tax-advantaged college fund plan is ESA. This plan has more restrictions than the 529 plan. You are limited to contribute only up to $2000 per child. There is also an income limit on this plan; your income should not exceed $220,000.
The good thing about this plan is that you will be able to withdraw money tax-free when you use it to pay for educational expenses.
Uniform Transfer To Minors Act (UTMA)/Uniform Gift To Minors Act (UGMA)
These custodial plans are also a tax-advantaged plan however the custodian will control the account until the child reaches the age of trust termination.
The good thing about this plan is that it is not limited to educational purposes only. When the child reaches 18 years of age, he will be able to use the money in whatever he wants.
The difference between UTMA and UGMA is that only basic assets are allowed to be donated to UGMA while UTMA allows other types of assets like real estate, royalties and more.
Also, UGMA terminates when the child turns 18 while the UTMA terminates later at 21.
While it is imperative that you prepare for your kid’s education, Dave also emphasized to teach your kids about how to be smart with money.
#6 Time to Ditch The House Debt
You are now closer to financial independence than ever before. You do not have any debt, you have a fully funded emergency fund, your retirement plan is growing and so are the college funds for your kids and now just one more obstacle-your mortgage.
Dave Ramsey recommends that you refinance your 30-year mortgage into a 15-year mortgage. However, if your interest rate is great, there is no need to refinance, you just have to make extra payments to pay off your mortgage in fifteen years.
You can use this FREE mortgage calculator to find out how much money and time you can shave off by paying extra every month.
It will take a lot of dedication to keep making extra payments but you’ve gotten this far–what’s a little bit more sacrifice.
#7 Build Wealth and Give More
This is it! You are now financially FREE.
In Baby Step Seven, Dave Ramsey drilled on three things, to have FUN, INVEST and GIVE.
You have reached your goal and now it’s time to enjoy all the fruits of your sacrifices. Keep investing so you can keep on growing. Finally, start giving and be rewarded mentally and spiritually.
There you have it!
Those are Dave Ramsey’s Baby Steps that will improve your life. In his book Total Money Makeover, he dove deeper into each of the baby steps and shared real-life stories that will inspire you.
Are you ready to improve your financial life? Grab Dave Ramsey’s The Total Money Makeover: A Proven Plan for Financial Fitness and start your journey to financial independence one step at a time.