Dave Ramsey's Debt Snowball, is it Wrong?

Dave Ramsey is a popular personal finance educator and radio host. Dave emphasizes staying away from debt and living within your means. Sounds pretty uncontroversial, doesn't it? Actually, Dave does stir up some controversy online, the main reason being that he does not always recommend that people do what seems mathematically optimal.

What does correct mean in finance? Many with some basic financial skills would tell you that it comes down to doing calculations on excel and maximizing bang for your buck wherever possible. This is not where Dave's advice lands, or so most people think, it's actually far more complicated.

Before we go deeper into the debate let's just review what makes the debt snowball controversial amongst those in the know. The snowball approach says to make the minimum payments on all your debts and then pay down the smallest one aggressively.

Many disagree with this approach because if the smallest debt isn't also the one with the highest interest rate it will take longer to pay off (all else being equal).

Let's Run the Numbers

Assume somebody has the following debt and payments are made annually. There are two ways we can pay these debts down. The Ramsey method and the traditional method. Using the Ramsey method we start with the smallest debt. Using the traditional method we start by paying down the one with the highest interest rate.

What is the difference in total cost if we choose one method or the other? I made a model to illustrate the difference.

The person who used the Dave Ramsey method paid $49,805 and the person who used the traditional method paid only $45,164 and save about $4,600.

Why would anybody choose the Ramsey method over the traditional method?

Dave Ramsey knows that the way he recommends is not the cheapest or quickest when modeled out using a spreadsheet, but there is a third variable that changes all of this. Human psychology. Think about it this way, the fastest way to pay down debt is to do it in such a way that you actually do it and don't give up halfway. Theoretically, every personal fiance prescription has a success rate and yes it depends on the patient.

Dave recommends the snowball method because he has found that his listeners have a higher success rate when using that method. Ultimately, paying off debt the wrong way is far cheaper than just never paying off debt. That method works for them because of their profile.

The profile of somebody who may need to use the snowball method is (in my opinion) the following.

1) Has multiple different types of debt

2) Goes into debt for things they don't need (consumer)

3) Has little financial education

4) Has attempted to pay down their debt before but can't overcome the many temptations.

What this person needs is motivation. They are used to using debt as a tool to satisfy their needs and desires, by going without it they are taking an emotional hit. By approaching the smallest debt first you can get the dopamine hit of success and progress you desperately need to propel you forward.

This is not to say that those who use the snowball are somehow lesser than, everybody has their sticking points, acknowledging them and adapting to overcome them is admirable.