Has anybody had success paying of debt with Dave Ramsey's theory?

[NFPWife]

Also, his debt snowball, while maybe making psychological sense in certain circumstances, doesn’t make mathematical sense (which he admits). If you have a $5,000 loan at a 4% interest rate and a $10,000 loan at a 25% interest rate, it is absolutely insane to pay the minimum on the $10,000 loan and pay down the $5,000 loan with his “debt snowball.” Just dumb.

It is purely psychological. It’s definitely counter-intuitive. It’s designed to help ppl maintain momentum through small wins and helps combat the defeating feeling of getting numerous bills in the mail each month. There’ve been some studies that, while the snowball method seems to be a more expensive option, ppl actually get out of debt. So paying slightly more interest during the process to finally pay NO interest is better long-term.

Here’s the Time article about the research on paying smallest debts first - business.time.com/2012/08/16/the-verdict-is-in-tackle-smaller-debts-first/

As I said, we were out of debt (house included) before I found DR. We paid off highest interest rates first and worked backwards because it made the most mathematical sense. We didn’t have motivation or discipline problems, and we were successful. There are ppl who start out trying the mathematical plan and lose traction and give up; as DR says, if ppl were good with math they wouldn’t need his system.

I’m working with a friend to help her get out of debt and I can say with 100% certainty that she would have been far less successful if she went with the highest interest rates first.

 

[Xantippe]

It is purely psychological. It’s definitely counter-intuitive. It’s designed to help ppl maintain momentum through small wins and helps combat the defeating feeling of getting numerous bills in the mail each month. There’ve been some studies that, while the snowball method seems to be a more expensive option, ppl actually get out of debt. So paying slightly more interest during the process to finally pay NO interest is better long-term.

Here’s the Time article about the research on paying smallest debts first - business.time.com/2012/08/16/the-verdict-is-in-tackle-smaller-debts-first/

As I said, we were out of debt (house included) before I found DR. We paid off highest interest rates first and worked backwards because it made the most mathematical sense. We didn’t have motivation or discipline problems, and we were successful. There are ppl who start out trying the mathematical plan and lose traction and give up; as DR says, if ppl were good with math they wouldn’t need his system.

I’m working with a friend to help her get out of debt and I can say with 100% certainty that she would have been far less successful if she went with the highest interest rates first.

Yes, and as DR says, if you were that good at math, you wouldn’t have wound up with thousands of dollars of high interest debt to begin with.

By paying off small debts first (and actually, a lot of those have very high interest–for instance department store credit cards), you streamline and destress your life and free up brain energy for making better decisions going forward.

 

[phillylawyer]

It is purely psychological. It’s definitely counter-intuitive. It’s designed to help ppl maintain momentum through small wins and helps combat the defeating feeling of getting numerous bills in the mail each month. There’ve been some studies that, while the snowball method seems to be a more expensive option, ppl actually get out of debt. So paying slightly more interest during the process to finally pay NO interest is better long-term.

Here’s the Time article about the research on paying smallest debts first - business.time.com/2012/08/16/the-verdict-is-in-tackle-smaller-debts-first/

As I said, we were out of debt (house included) before I found DR. We paid off highest interest rates first and worked backwards because it made the most mathematical sense. We didn’t have motivation or discipline problems, and we were successful. There are ppl who start out trying the mathematical plan and lose traction and give up; as DR says, if ppl were good with math they wouldn’t need his system.

I’m working with a friend to help her get out of debt and I can say with 100% certainty that she would have been far less successful if she went with the highest interest rates first.

I get the psychological side of it. So, if the psychological factor is really that important, pay all the extra towards the higher interest rate loan first. Then, once you have paid enough on the high interest rate loan that you would have paid off the low balance lower interest loan, refinance (or do a balance transfer) on your two higher interest rate lows into one loan. That way, you have now had the psychological “win” of reducing the number outstanding accounts by one, but you haven’t paid the banks a bunch of extra interest for the right to do it.

There is no difference between 10 loans at 10k each and one loan at 100k. The difference is purely psychological. And, if that psychological difference is significant to some people (which I can see how it would be), using the above method (or similar ones, there are a number of simple ways to do this) can encourage the psychological “reward” part of it, without the additional cost (possibly thousands of dollars over years) of overpaying interest.

At the very least, anyone advising someone on getting out of debt, should calculate the debt snow ball method and the higher interest rate first method (sometimes called the debt avalanche) and explain to them how much extra in interest it will cost them to use Ramsey’s method. if they think it is worth the extra interest cost to do so, then fine. But, they at least have a right to be informed of what that cost is.

 

[phillylawyer]

Yes, and as DR says, if you were that good at math, you wouldn’t have wound up with thousands of dollars of high interest debt to begin with.

By paying off small debts first (and actually, a lot of those have very high interest–for instance department store credit cards), you streamline and destress your life and free up brain energy for making better decisions going forward.

Actually, a lot of people who are good at math do end of thousands of dollars in debt. The problem is not being bad at math, the problem is (1) spending more than you can afford and (2) not being informed about how all of this finance/interest rate/credit card stuff works.

Dave’s approach may help with #1, but I fail to see how giving them bad advice about how loans and interest work (or should work) helps with #2. That is really just encouraging ignorance about finance, if you ask me (that combined with his ignorant advice about paying off mortgages, IRA vs. Roth’s, and his unrealistic 12% return on stock investments).

I applaud Dave’s effort at making sure people are financially savvy and encouraging them to get out of debt. However, he can do that without the naive (and in some cases financially harmful) advice that goes with it.

 

[PaulGH]

Another statement of Dave’s that is flat out wrong in his book:

"Let’s say you’re 30 years old bringing home $40,000 a year. If you put 15% of that into retirement, that’s $6,000 a year – $500 a month. If you put $500 a month into good growth stock mutual funds that average 12% from 30-70 years old, then you would have almost $6 million. Over 40 years, you’ve put in $240,000 and your return is $6 million.

If you do that in a 401K, that money is taxable. The money went in before taxes, but the money is taxable as it comes out. Your $240,000 that went in pre-tax is almost irrelevant in light of the $6 million that is going to be taxed.

But if you put money in a Roth IRA, it grows tax-free. That means if you put the same amount into the Roth, you’ve got $6 million, none of which goes to Uncle Sam. The Roth IRA is always superior to the 401K because of this."

That last sentence is just flat out wrong. If your tax rate is higher when you take your money out than when you put it in, he is right. If the opposite, then he is dead wrong. Again, the one size fits all simplistic financial advice is sometimes painful to read.

Yes, I have mentioned to my wife many times how Dave Ramsey is wrong on his take on Roth IRA vs. 401(k). He claims that the Roth IRA is always better. (Or at least he did when I used to listen to him regularly a few years ago.) But really it depends on whether your tax rate is higher now or when you retire, as you said. I think I see what Dave is doing though. I think he is figuring it this way:

You can put $1000 in a 401(k), and then it grows tax-free, but you have to pay taxes on it when you withdraw it. Or you can put $1000 in a Roth IRA, and it also grows tax-free, and you never have to pay taxes when you withdraw it (provided you have reached retirement age). If you compare it that way, then yes you will end up with more money by putting $1000 in the Roth IRA, which is what he concludes.

But what he seems to overlook is that you didn’t pay any tax up-front on the $1000 that you put in the 401(k), while you did have to pay tax on the $1000 that you put in the Roth IRA. So the $1000 you put in the Roth IRA actually cost you more – i.e., it represents a bigger percentage of your income – than the $1000 in the 401(k). Therefore, this is not really a valid apples-to-apples comparison.

A better comparison would be to say that you would save $300 in taxes by putting $1000 in the 401(k). So then you would compare a $1000 401(k) contribution to a $700 Roth IRA contribution, which is actually a fair comparison, if that $300 tax estimate is correct. And in that case, which one is better depends entirely on your income tax rate now vs. your income tax rate at retirement.

Since I have no way to know whether my income tax rate will be higher or lower at retirement, I try to split the difference, and put about half of my retirement savings in a 401(k), and about half in Roth IRAs.

 

[phillylawyer]

Here’s the Time article about the research on paying smallest debts first - business.time.com/2012/08/16/the-verdict-is-in-tackle-smaller-debts-first/

This is a classic case of correlation does not equal causation. If people in debt were randomly assigned into two groups, the Debt Snowball and the Debt Avalanche Group, then we may be able to infer some causal relationships based on the results. But, unfortunately, even assuming the rest of the study is sound, all we could conclude from this study is correlation.

 

[NFPWife]

I get the psychological side of it. So, if the psychological factor is really that important, pay all the extra towards the higher interest rate loan first. Then, once you have paid enough on the high interest rate loan that you would have paid off the low balance lower interest loan, refinance (or do a balance transfer) on your two higher interest rate lows into one loan. That way, you have now had the psychological “win” of reducing the number outstanding accounts by one, but you haven’t paid the banks a bunch of extra interest for the right to do it.

There is no difference between 10 loans at 10k each and one loan at 100k. The difference is purely psychological. And, if that psychological difference is significant to some people (which I can see how it would be), using the above method (or similar ones, there are a number of simple ways to do this) can encourage the psychological “reward” part of it, without the additional cost (possibly thousands of dollars over years) of overpaying interest.

At the very least, anyone advising someone on getting out of debt, should calculate the debt snow ball method and the higher interest rate first method (sometimes called the debt avalanche) and explain to them how much extra in interest it will cost them to use Ramsey’s method. if they think it is worth the extra interest cost to do so, then fine. But, they at least have a right to be informed of what that cost is.

True, my friend and I laid everything out and went over the pros and cons of these methods and a, less common, method based on the monthly payment. She knows herself. She went for the DR snowball. We did advocate (strongly!) with the credit cards to get all the interest rates lowered and, in the end, they were all pretty close. That helped level the playing field between the methods (and made my “math brain” feel better.) She wouldn’t have been able to get a loan or another credit card to “surf” things onto.

We’re doing something very non-Dave with her student loads - it’s another area where the general advice is good, but might not fit every situation.

I think if DR gets ppl thinking about their money and being intentional with their plans, then he’s doing a great service.

 

[phillylawyer]

Yes, I have mentioned to my wife many times how Dave Ramsey is wrong on his take on Roth IRA vs. 401(k). He claims that the Roth IRA is always better. (Or at least he did when I used to listen to him regularly a few years ago.) But really it depends on whether your tax rate is higher now or when you retire, as you said. I think I see what Dave is doing though. I think he is figuring it this way:

You can put $1000 in a 401(k), and then it grows tax-free, but you have to pay taxes on it when you withdraw it. Or you can put $1000 in a Roth IRA, and it also grows tax-free, and you never have to pay taxes when you withdraw it (provided you have reached retirement age). If you compare it that way, then yes you will end up with more money by putting $1000 in the Roth IRA, which is what he concludes.

But what he seems to overlook is that you didn’t pay any tax up-front on the $1000 that you put in the 401(k), while you did have to pay tax on the $1000 that you put in the Roth IRA. So the $1000 you put in the Roth IRA actually cost you more – i.e., it represents a bigger percentage of your income – than the $1000 in the 401(k). Therefore, this is not really a valid apples-to-apples comparison.

A better comparison would be to say that you would save $300 in taxes by putting $1000 in the 401(k). So then you would compare a $1000 401(k) contribution to a $700 Roth IRA contribution, which is actually a fair comparison, if that $300 tax estimate is correct. And in that case, which one is better depends entirely on your income tax rate now vs. your income tax rate at retirement.

Since I have no way to know whether my income tax rate will be higher or lower at retirement, I try to split the difference, and put about half of my retirement savings in a 401(k), and about half in Roth IRAs.

Yes. Excellent analysis. On the one hand, I generally think income tax rates are going up in this country, which would lead to Dave’s conclusion about using a Roth. On the other hand, most people have lower income in retirement than in peak working years (meaning lower marginal tax rates), pointing toward using a traditional IRA.

I think you are right that Dave’s thinking is simple, along the lines of what you conclude. This is also similar to his financially illiterate commentary on paying off a mortgage early and the impact of the mortgage interest deduction. I can’t tell if he genuinely doesn’t understand finance enough to know that his comments are wrong, or he knows it is wrong, but says it anyone because simple, authoritative, blanket statements come across as more confident and authoritative and sell more books/cd/seminars.

 

[phillylawyer]

True, my friend and I laid everything out and went over the pros and cons of these methods and a, less common, method based on the monthly payment. She knows herself. She went for the DR snowball. We did advocate (strongly!) with the credit cards to get all the interest rates lowered and, in the end, they were all pretty close. That helped level the playing field between the methods (and made my “math brain” feel better.) She wouldn’t have been able to get a loan or another credit card to “surf” things onto.

We’re doing something very non-Dave with her student loads - it’s another area where the general advice is good, but might not fit every situation.

I think if DR gets ppl thinking about their money and being intentional with their plans, then he’s doing a great service.

That’s great! It is nice of you to spend that time with your friend and help him/her get out of debt. As long as she knows that there will be extra interest cost associated with the Ramsey method, but chooses to do it anyway, at least she is making an informed choice. Just out of curiosity, when you ran the numbers, what was the estimated additional interest cost associated with using the snow ball method instead of the higher interest rate first method?
That is my beef with Ramsey’s advocacy of that method. If he said that people should run the calculations with both numbers, and in many cases choose the “more expensive option” for psychological reasons, but should do so in an informed manner, fine. But, his simple, one-sized fits all approach in most circumstances leads people not to even consider the cost and do so in an uninformed manner. As you said, you aren’t following Dave’s method for student loans. Which is exactly how it should be. Each situation is different, and it sounds like you are giving your friend great advice!

As you mentioned, if Ramsey gets people thinking about finances and debt, that is great. But, what often got people into trouble was making uninformed decisions in the first place. I don’t think Dave encouraging yet another uninformed decision is the best approach.

 

[NFPWife]

Yes, I have mentioned to my wife many times how Dave Ramsey is wrong on his take on Roth IRA vs. 401(k). He claims that the Roth IRA is always better. (Or at least he did when I used to listen to him regularly a few years ago.) But really it depends on whether your tax rate is higher now or when you retire, as you said. I think I see what Dave is doing though. I think he is figuring it this way:

You can put $1000 in a 401(k), and then it grows tax-free, but you have to pay taxes on it when you withdraw it. Or you can put $1000 in a Roth IRA, and it also grows tax-free, and you never have to pay taxes when you withdraw it (provided you have reached retirement age). If you compare it that way, then yes you will end up with more money by putting $1000 in the Roth IRA, which is what he concludes.

But what he seems to overlook is that you didn’t pay any tax up-front on the $1000 that you put in the 401(k), while you did have to pay tax on the $1000 that you put in the Roth IRA. So the $1000 you put in the Roth IRA actually cost you more – i.e., it represents a bigger percentage of your income – than the $1000 in the 401(k). Therefore, this is not really a valid apples-to-apples comparison.

A better comparison would be to say that you would save $300 in taxes by putting $1000 in the 401(k). So then you would compare a $1000 401(k) contribution to a $700 Roth IRA contribution, which is actually a fair comparison, if that $300 tax estimate is correct. And in that case, which one is better depends entirely on your income tax rate now vs. your income tax rate at retirement.

Since I have no way to know whether my income tax rate will be higher or lower at retirement, I try to split the difference, and put about half of my retirement savings in a 401(k), and about half in Roth IRAs.

He’s starting to shift on the Roth is always better hard line. I’ve heard a couple calls recently where he advised against a Roth. That’s why I like the show better than his books. The show is less “one size fits all.”

 

[phillylawyer]

He’s starting to shift on the Roth is always better hard line. I’ve heard a couple calls recently where he advised against a Roth. That’s why I like the show better than his books. The show is less “one size fits all.”

I will admit I have not listened to his show and have only read his book (and some stuff from his website). So, my entire impression of him has come from that and a few friends who have gone through the FPU course. That is good to know that his radio advice is more tailored to a person’s situation and perhaps more nuanced (and financially literate?) than his book can be at times.

As I’ve said, I like some of things that Ramsey has to say, and I know people have benefited from his program. And, improved financial literacy and getting people to think about and understand money is great.

But, as someone who does a lot of financial planning (I’m an estate planning attorney) for a living, some of the stuff he says comes across as more concerned about selling books (because simple, one-sized fits all, one-liners gets you more publicity and book sales than nuanced advice does) than giving good advice. That type of thing drives me nuts.

 

[PaulGH]

Also, a couple of other pieces of financial advice that Dave Ramsey gives out that is either naive or flat out wrong:

From his book total money makeover, in talking about paying off a mortgage:

“This situation is one more opportunity to discover if your CPA can add. If you do not have a $10,000 tax deduction and you are in a 30 percent bracket, you will have to pay $3,000 in taxes on that $10,000. According to the myth, we should send $10,000 in interest to the bank so we don’t have to send $3,000 in taxes to the IRS. Personally, I think I will live debt-free and not make a $10,000 trade for $3,000. However, any of you who want $3,000 of your taxes paid, just e-mail me and I will personally pay $3,000 of your taxes as soon as your check for $10,000 clears into my bank account. I can add.” [Page 187]

Really? This is so mathematically naive (especially for a guy claiming you can get a 12% return by investing in stocks) it’s hard to take it seriously.

I am guessing there may be a bit more context that would clarify that quote, but it sounds like he is making the same point he has made on his radio show many times. Basically, he is arguing against people who say that it is good to pay interest on a mortgage, because that interest is tax-deductible. Sometimes people who make this claim make it sound as if you will actually save money by paying mortgage interest, or that you will save an amount on your taxes equal to your mortgage interest. But, as Dave points out, this is flat wrong.

To use his example, let’s say that you paid $10,000 in mortgage interest in 2014, and now it is spring of 2015 and you are doing your 2014 federal income taxes. The way that some people promote mortgage interest, you could easily think that you are going to save $10,000 on your 2014 income tax bill, thus making your mortgage interest essentially free. But this is not true. Here’s how it actually works, as you probably know:

For simplicity, let’s assume that you have enough other deductions besides mortgage interest (e.g., property tax, charitable giving) to go over your standard deduction. In that case, the $10,000 of mortgage interest means that $10,000 of your income is not taxable. So if you would have had $80,000 of taxable income, you now have only $70,000 of taxable income. This does not mean that you save $10,000 in taxes, but rather that you save the income tax that you otherwise would have paid on that extra $10,000 of income. And that might be more like $2500 or $3000.

So in this example, if you took on a mortgage or avoided paying off a mortgage, in order to save on your taxes, then you have done exactly what Dave Ramsey says you did: You sent $10,000 to the bank (as interest on your mortgage) in order to avoid sending something like $2500 or $3000 to the government.

(And one thing that Dave fails to point out is that in practice, the amount you save on your taxes may be even less than this example indicates. If you don’t have other large deductions, like high property taxes or a large amount of charitable giving, then your mortgage interest may not even take you over the standard deduction, or it may take you over the standard deduction by only a small amount. And you would get to take the standard deduction anyway, even without the mortgage interest. So your actual savings could be much less than the $3,000 in his example – possibly even $0 if your total deductions with mortgage interest are still lower than the standard deduction. But that only makes his point even stronger.)

 

[phillylawyer]

She wouldn’t have been able to get a loan or another credit card to “surf” things onto.

You are right that for someone with really bad credit, it’s not just as simple as combining two credit accounts into one. In my experience, there usually is a pretty simple way to reduce the number of outstanding accounts, but that can be a hurdle at times.

When I have worked with people who are really interested in the psychological factor, I show them the extra interest it will cost them to do the Ramsey method, and then suggest that they combine two accounts into one when they have paid off a certain amount for that psychological boost. By the time they get to the point where they would have paid off one account, I suggest a couple of methods to do this, and they just laugh and say, “I have developed these habits already, and the psychological benefit is coming from seeing the total balance drop.”

I will say that, if people have some really small loans (a couple hundred bucks), even if the interest rate is lower than some other large balances, I suggest getting those paid off quickly. For such small accounts, the extra “interest cost” of paying those off first is only a few bucks, and it isn’t worth the hassle of keeping all those accounts open or trying to refinance into a new account.

 

[PaulGH]

He’s starting to shift on the Roth is always better hard line. I’ve heard a couple calls recently where he advised against a Roth. That’s why I like the show better than his books. The show is less “one size fits all.”

That’s good to know. I haven’t listened to him as much in the past several years. I really used to listen to him a lot around 2003 to 2008, but not as much since then. Back then, he claimed many times that the Roth IRA was always the better option. Maybe someone finally pointed out the flaw in his math, and he has started to back-pedal a bit.

Nevertheless, I still have always had a high regard for his advice in general, because regardless of the specifics, the basics of his message are something that so many people (myself included) need to hear. And I think that his advice to callers is usually spot-on.

 

[phillylawyer]

I am guessing there may be a bit more context that would clarify that quote, but it sounds like he is making the same point he has made on his radio show many times. Basically, he is arguing against people who say that it is good to pay interest on a mortgage, because that interest is tax-deductible. Sometimes people who make this claim make it sound as if you will actually save money by paying mortgage interest, or that you will save an amount on your taxes equal to your mortgage interest. But, as Dave points out, this is flat wrong.

To use his example, let’s say that you paid $10,000 in mortgage interest in 2014, and now it is spring of 2015 and you are doing your 2014 federal income taxes. The way that some people promote mortgage interest, some people are led to believe that you are going to save $10,000 on your 2014 income tax bill, thus making your mortgage interest essentially free. But this is not true. Here’s how it actually works, as you probably know:

For simplicity, let’s assume that you have enough other deductions besides mortgage interest (e.g., property tax, charitable giving) to go over your standard deduction. In that case, the $10,000 of mortgage interest means that $10,000 of your income is not taxable. So if you would have had $80,000 of taxable income, you now have only $70,000 of taxable income. This does not mean that you save $10,000 in taxes, but rather that you save the income tax that you otherwise would have paid on that extra $10,000 of income. And that might be more like $2500 or $3000.

So in this example, if you took on a mortgage or avoided paying off a mortgage, in order to save on your taxes, then you have done exactly what Dave Ramsey says you did: You sent $10,000 to the bank (as interest on your mortgage) in order to avoid sending something like $2500 or $3000 to the government.

(And one thing that Dave fails to point out is that in practice, the amount you save on your taxes may be even less than this example indicates. If you don’t have other large deductions, like high property taxes or a large amount of charitable giving, then your mortgage interest may not even take you over the standard deduction, or it may take you over the standard deduction by only a small amount. And you would get to take the standard deduction anyway, even without the mortgage interest. So your actual savings could be much less than the $3,000 in his example – possibly even $0 if your total deductions with mortgage interest are still lower than the standard deduction. But that only makes his point even stronger.)

Paul,

Of course you are right that your deduction never cancels out your interest payment. Your mortgage deduction only serves to reduce the effective rate of your mortgage. Your above explanation is exactly spot on.

But, the reason that Dave’s advice is either misleading or just wrong, is because the correct comparison is not between paying $10,000 and getting $3,000 back, or paying nothing and getting nothing back.

Instead, assume that you have a $250,000 mortgage at a 4% interest rate (reasonable based on current rates). This means that your annual interest payment is $10,000 (which is why I chose those numbers), and, if you are in a 30% marginal tax bracket, you get $3,000 back from the government, making the interest cost effectively $7,000.

In order to get rid of that interest payment, you need to pay off the entire $250,000 mortgage. Therefore, assuming you have $250,000 of cash sitting around, the choice is between using the $250,000 to pay of your mortgage (“earning” you $7,000 in net interest savings) or investing the cash in the market.

Using Dave’s unrealistic 12% investment returns, you would earn $30,000 per year investing that $250,000, much better than the $7,000 in annual savings by paying of the mortgage. Even assuming a more realistic 8% investment return (and throwing in a 15% Long-term capital gains tax with a 100% turnover rate on your investments) you still net $17,000 after taxes on those investments.

Later on in that segment, Dave does make reference to the fact that the analysis is more complicated. But, in order to still suggest paying off your mortgage instead of investing, he has to essentially talk down the 12% return and talk up the risk. In doing so, he undercuts a lot of his other advice, where he assumes you can get 12% return on investments.

Again, these types of things make it look like he is more interested in selling books than giving good solid financial advice.

 

[PaulGH]

Paul,

Of course you are right that your deduction never cancels out your interest payment. Your mortgage deduction only serves to reduce the effective rate of your mortgage. Your above explanation is exactly spot on.

But, the reason that Dave’s advice is either misleading or just wrong, is because the correct comparison is not between paying $10,000 and getting $3,000 back, or paying nothing and getting nothing back.

Instead, assume that you have a $250,000 mortgage at a 4% interest rate (reasonable based on current rates). This means that your annual interest payment is $10,000 (which is why I chose those numbers), and, if you are in a 30% marginal tax bracket, you get $3,000 back from the government, making the interest cost effectively $7,000.

In order to get rid of that interest payment, you need to pay off the entire $250,000 mortgage. Therefore, assuming you have $250,000 of cash sitting around, the choice is between using the $250,000 to pay of your mortgage (“earning” you $7,000 in net interest savings) or investing the cash in the market.

Using Dave’s unrealistic 12% investment returns, you would earn $30,000 per year investing that $250,000, much better than the $7,000 in annual savings by paying of the mortgage. Even assuming a more realistic 8% investment return (and throwing in a 15% Long-term capital gains tax with a 100% turnover rate on your investments) you still net $17,000 after taxes on those investments.

Later on in that segment, Dave does make reference to the fact that the analysis is more complicated. But, in order to still suggest paying off your mortgage instead of investing, he has to essentially talk down the 12% return and talk up the risk. In doing so, he undercuts a lot of his other advice, where he assumes you can get 12% return on investments.

Again, these types of things make it look like he is more interested in selling books than giving good solid financial advice.

I haven’t read Dave’s books, and it is possible that he says something a bit different in his books. But based on many hours of listening to his radio show over several years, I don’t think he is arguing what you think he is arguing. When he talks about how it doesn’t make sense to send $10,000 to the bank in order to avoid sending $3,000 to the government (which he has mentioned many times on his show), I have always understood him to be arguing against the false idea that the tax deduction completely offsets any interest payment, so that the mortgage effectively costs you nothing in interest once taxes are figured in.

Now perhaps it could make sense to send $10,000 to the bank for some **other **reason, besides saving on taxes, but as I understand him, he isn’t addressing any other reasons with this particular argument – he is only addressing the tax fallacy.

Dave does also argue that you should not delay paying off your mortgage in order to increase your investing (beyond the 15% you should already be putting into retirement, and the money you should be saving for college if you have kids). But there, he makes his argument in terms of risk, not in terms of tax deductions.

 

[NFPWife]

Oops, I misspoke, I just looked at my notes and we violated some snowballs rules with my friend’s debt. She had a six month same as cash thing that was about to expire and jump to 28% with all the back interest. My exact words were, “Oh, h*** no!” She sold some things and we paid that off before it expired. That took two months. During that two months, we looked at everything else, negotiated lower interest rates on CCs and, generally, had a little time to move forward in a plan-full manner while she still had a sense of accomplishment.

We had all the credit cards between 8-10% and the largest balance was the second to lowest rate; it would have been a $400 difference. She picked up a little extra income and it went faster than planned. Since we started, she’s also gotten a new job, pay increase, and, just yesterday, we were working on how to negotiate a raise.

Some of the DRisms were really helpful when she encountered “feedback” from others. When she stopped taking lunch to work, ppl started asking questions and she said she was on a budget and getting out of debt. We’d already planned that ppl would want to give advice and rehearsed what to do – she’d ask, “What’s your net worth?” If they didn’t know what that meant or what it was, she’d explain that she wanted them to add up what they owed vs. what they owned and if they were broke, they could stop talking she wasn’t taking advice from broke ppl. Not only did the unsolicited advice stop, but ppl started asking her questions. They also started a potluck one day a week for lunch.

The biggest changes we made were in how she could economize and in keeping her on budget through the month. We laugh (now) about the arguments we had. For instance, she insisted she could only use Mary Kay cleanser. She’d just been complaining about how expensive gasoline was, so I made her calculate the price per gallon for the cleanser. Then, we looked at reviews of it online. She’s using Johnson’s baby wash (which, btw, is the same thing as Purpose – different aisle, different bottle, lower price.) She’d text me and say, “Can I buy X” and have some major justification for it. I’d reply, “Not in the budget. Not an emergency. Remember Pearl Harbor? That was almost an emergency.” She’s gotten so disciplined.

 

[NFPWife]

PaulGH is right about the mortgage advice. It’s much more nuanced. Accelerating to get the mortgage paid off comes behind funding retirement at 15% and behind saving for kids’ college. He also assumes that you’ll save/ invest a large portion of the mortgage payment moving forward. He does “Why send the bank $10K to avoid sending the govt. $3K” to challenge the notion that mortgage debt is “good” debt. I’ve actually had a CPA friend tell us we were “stupid” to pay off our house in 8 years. Another friend said we were stupid to pay off student loans.

He just had a call yesterday where a daughter was asking if her mother should take money out of her 401K and pay off the house to get out of debt. After he went through the details (mom was old enough to withdraw,) he gave an unequivocal “No.” It would use most of her nest egg; also, she makes enough income to pay off the house in a year.

He has advised ppl to use inheritances and other windfalls to pay off their houses, after fully funding retirement and kids’ college funds, instead of investing the money. He acknowledged that it was about risk - “100% of foreclosed homes had a mortgage.”

 

[phillylawyer]

I haven’t read Dave’s books, and it is possible that he says something a bit different in his books. But based on many hours of listening to his radio show over several years, I don’t think he is arguing what you think he is arguing. When he talks about how it doesn’t make sense to send $10,000 to the bank in order to avoid sending $3,000 to the government (which he has mentioned many times on his show), I have always understood him to be arguing against the false idea that the tax deduction completely offsets any interest payment, so that the mortgage effectively costs you nothing in interest once taxes are figured in.

Now perhaps it could make sense to send $10,000 to the bank for some **other **reason, besides saving on taxes, but as I understand him, he isn’t addressing any other reasons with this particular argument – he is only addressing the tax fallacy.

Dave does also argue that you should not delay paying off your mortgage in order to increase your investing (beyond the 15% you should already be putting into retirement, and the money should be saving for college if you have kids). But there, he makes his argument in terms of risk, not in terms of tax deductions.

You are right that he further addresses this in terms of risk in his book. But, in my situation, I have a mortgage with a 3.25% interest rate. With the income tax deduction, the “effective rate” of that mortgage is 30% less, or about 2.275%.

So, my choice is between paying off my mortgage early, which is a “guaranteed” return of 2.275%, or investing in something else (stocks, bonds, etc.). Dave explains that the 12% investment has higher risk, so the return should be risk-adjusted (which sort of undercuts the rest of his philosophy about buying term investing the difference, etc. based on a 12% rate of return - but, that’s a different story). However, that applies to any investment.

Paying off a mortgage with an effective interest rate of 2.275% is financially and mathematically equivalent to investing in an asset (or bond) with a guaranteed return of 2.275%. If Dave’s argument is that an investment with a guaranteed rate of return of 2.275% is always better than investing in the stock market, then that logic should apply across the board. You can invest in treasury bonds that have a guaranteed rate of return of 2.275% and, using Dave’s logic, you should NEVER invest in the market and always invest in those, because there is some risk to investing in the market. Everybody knows that advice is silly.

Dave (obviously) does not endorse that idea, because he incorrectly treats early repayment of mortgage (because it’s “debt”) differently than investing in low-risk bonds or some other asset with a fixed rate of return. Either Dave is being intentionally misleading, or he is just uninformed. And, most of his readers/listeners who do not understand this finance (because it is not their job and don’t get paid to do so) won’t realize this.

The below blog actually does a pretty good job reviewing Dave’s discussion in this section of his book and explaining the problems with his arguments. I thought about pasting in the entire blog into this post, but it was too long (and I write too verbosely already!).

badmoneyadvice.com/2009/04/ramseys-step-6-pay-off-the-mortgage.html

 

[phillylawyer]

PaulGH is right about the mortgage advice. It’s much more nuanced. Accelerating to get the mortgage paid off comes behind funding retirement at 15% and behind saving for kids’ college. He also assumes that you’ll save/ invest a large portion of the mortgage payment moving forward. He does “Why send the bank $10K to avoid sending the govt. $3K” to challenge the notion that mortgage debt is “good” debt. I’ve actually had a CPA friend tell us we were “stupid” to pay off our house in 8 years. Another friend said we were stupid to pay off student loans.

He just had a call yesterday where a daughter was asking if her mother should take money out of her 401K and pay off the house to get out of debt. After he went through the details (mom was old enough to withdraw,) he gave an unequivocal “No.” It would use most of her nest egg; also, she makes enough income to pay off the house in a year.

He has advised ppl to use inheritances and other windfalls to pay off their houses, after fully funding retirement and kids’ college funds, instead of investing the money. He acknowledged that it was about risk - “100% of foreclosed homes had a mortgage.”

At least in his book (as I said to Paul above), his advice about paying off mortgages is, to be honest, flat out financially illiterate. I’m not sure if he does it on purpose to make a point or because he is uninformed. Maybe (hopefully?) it is more nuanced on his radio show.

As you said, of course mortgage debt is not “good” debt. Other than a few differences in the legal implications of bankruptcy and how it is treated with certain loan applications (and low income repayment options for student loans), debt is debt is debt. Mortgage debt is no different.

What IS different about mortgage debt is that, because the interest is tax deductible on your federal income tax return in the U.S., assuming you are itemizing on your federal tax return (and not taking the standard deduction), the EFFECTIVE interest rate on your mortgage is actually lower than what is quoted to you. If you have a 3.25% mortgage and are in a 30% marginal tax bracket, your effective interest rate is 2.275%. This is financially equivalent to having non-mortgage (non-deductible) debt with a rate of 2.275%.

What this means is, when deciding whether to pay off your mortgage early or invest the cash in something else, you should treat paying off the mortgage early as investing in an asset with a guaranteed return of 2.275% (or whatever the effective rate of your mortgage is) because they are financially equivalent. If a guaranteed return of 2.275% is the best investment (or at least the best option as part of your investment portfolio) when compared to other investment options (adjusted for risk) then you should. If not, you shouldn’t. Simple. The fact that is called “debt” does not change this analysis.

At 2.275%, for most people, the answer is it is not the best investment option. Would you move substantial money out of an indexed mutual fund to invest in a treasury bond with a yield of 2.275%? If the answer is no, you shouldn’t use that money to pay off your mortgage early, either.

Dave’s one-size fits all advice about paying it off early is, again, financially naive, and wrong in most cases. And, what is especially ridiculous about this advice is in other places in his book he assumes investing in the stock market will give you a fixed return of 12%. That makes it even more ridiculous.