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Column

There's a payoff in thinking small

Dear Dave,

I’ve heard lots of different theories and recommendations when it comes to paying off debt. Why do you advise paying off debts from smallest to largest?

– Marlee

Dear Marlee,

A lot of people wonder the same thing when I bring up the debt snowball. Some think paying off the debt with highest interest rate first is the best approach. This may seem to make sense mathematically, but I realized a long time ago debt is not a mathematics problem – it’s a behavior problem. Personal finance is 80 percent behavior, and only 20 percent head knowledge. Besides, if all those people were so great at math, they wouldn’t be up to their eyeballs in debt in the first place!

The reason the debt snowball pays off debt from smallest to largest is that modifying your behavior and providing inspiration to get out of debt is more important than the math. Your probability of becoming wealthy is more closely connected to your behavior than your financial “sophistication” or academic pedigree.

When you pay off a small debt you experience success, and that gives you hope. Then, you move on the next debt. When you pay that one off, and you’ve wiped out two debts, it really energizes you. At that point you start to get excited, and you begin to believe in yourselfand in the fact you’re actually on the road to becoming debt-free!

– Dave

Rentals aren't easy money

Dear Dave,

I’m 35, and I’ve always wanted to own rental property. I think I’ve found a deal that would work for me. I want to take $20,000 out of my thrift savings account to use as a down payment on the property. I could rent the place for $1,400 a month, and my loan payment would be $1,100 a month. What do you think about this idea?

– Nathan

Dear Nathan,

I love real estate, so I understand the allure. But what you’re telling me is you want to cash out part of your retirement, get hit with a penalty and take on debt to buy an investment property. I wouldn’t do it.

I’ve got a feeling you’ve never been a landlord before. Bringing in $1,400 and paying out $1,100 may seem like a good place to be, but you haven’t figured all the risk into your equation. Rental properties just sit there empty sometimes. Other times you have renters who don’t pay, repairs, and people who just tear up things. In other words, you won’t be able to count on an easy $300 in your pocket every month.

Like I said, I totally get your fascination with real estate. But my advice is to save up, and pay cash for one decent rental property to see if this game is really for you.

– Dave

Follow Dave on Twitter (@DaveRamsey), or go to daveramsey.com.

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