AskDong

I’m not a follower of Dave Ramsey, but having read a lot of personal finance sites and blogs, I’ve come across his teachings and his books more than a few times. I applaud his efforts, and his success at helping thousand of individuals climb out of debt. That said, I don’t think his way is the only way. While I probably agree more than I disagree with Mr. Ramsey, his draconian attitude towards all types debt instruments is not for me.. I have over a dozen credit cards, but I don’t carry a balance. I have a mortgage, but it’s at a great fixed rate with more than manageable payments. I think like anything else borrowing money is just another tool. It’s not evil or bad in itself. I have no great love for many of the tactics that credit card companies employ, but I don’t believe them to be any more evil than many other companies. Personally I prefer the credit card companies over cable providers any day as there is more competition. Credit card companies offer a service and are trying to make money like any other business. Like any profit driven business, credit card companies are trying to keep customers and extract as much out of them either through interest payments or transaction charges (billed to the retailers). As long as there are number of credit card companies competing for customers, I’m generally OK with their business model.

Dave Ramsey, on the other hand, hates credit card companies, and all forms of debt with a passion. I’ve actually never read any of his books, or listened to his show. Most of what I know about him comes from post by other personal finance bloggers, and comments from other personal finance blog readers. While I think that most people who look to Dave Ramsey as a personal finance guru are more than reasonable, I have found a minority of his followers incredibly dogmatic in their approach to personal finances. Given that I’m not following his way and I have very strong moderate tendencies (I have a hard time accepting any one answer without also acknowledging some reason in the counter position), I raise an eyebrow when I see people espousing Dave’s way is the only way.

From what I understand of Dave Ramsey, his basic pitch is that all debt is bad debt. Don’t use credit cards. Don’t have a mortgage. I’m not a fan of debt either, but I don’t think all debt is bad debt. When it comes to actually down to paying debt, he pushes the “debt snowball” - pay down the smallest loan, and then move to next larger one once that’s been paid. Rationally speaking paying down the smallest debt doesn’t make sense, paying the highest interest loan does. However, I think from a purely psychological perspective Dave’s advice is good. People often need to feel like they’re meeting goals.

Again since I’ve never listened to his show or read his books, what little I know that comes from him directly is from his website. While I don’t agree with him 100% as I wouldn’t usually expect to agree with anyone 100%, I think his arguments are well constructed and don’t strike me as particularly dogmatic. However, I also know that Dave Ramsey has a strong reputation as a powerful speaker who draws on his own Christianity to illustrate points. I imagine some of his force is lost when his words are translated to text on a page. I guess the broader question is not why followers of Dave Ramsey’s are so dogmatic as much as why some followers of any expert/guru feel the need to disparage and completely discount any conflicting view. Personal finances can be complicated. I readily acknowledge much of it is behavioral and psychological rather than mathematical and rational. Exactly because of the large psychological component, I believe there are many different “right” answers.

I don’t write much about debt, but handling debt is probably one of the most important parts to personal finance.  The reason I don’t write about debt very much is because I’ve been lucky enough to only have “good” debt, e.g., student loans and mortgage, both of which are at low fixed rates.  I’m one of the lucky few.  Many, if not most Americans struggle with debt.  The other day I was talking with my friend, Mary Ann, about her credit card debt, trying to give her some advice on how to tackle it.  It’s easy to say pay if off, but it’s harder to come up with a concrete plan.  Given that the interest rate on her credit card is at 20%, finding creative ways to pay off that debt quickly can make a huge difference even in a few months.

Before I start examining specific strategies, I also believe it’s critical to make that debt tangible in some way.  I believe many individuals get into credit card trouble because debt itself is an ephemeral beast. Debt has no physical body.  Debt makes no sound but still manages to keep some people up at night.  Trent at The Simple Dollar suggests creating a visual reminder of debt such as progress bar.  This is a fantastic idea, as it serves to remind us of our obligations, and serves as positive reinforcement of good behavior.  I didn’t really start making true progress with my own finances until I started tracking my monthly net worth.  A simple visual reminder can be simply writing down how much debt you have at the beginning and at the end of each month on a 12 month calendar.

Mary Ann doesn’t have an enormous amount of credit card debt, only $5,220. However, even that small amount at 20% interest means she’s paying about $87 in interest a month!

My first suggestion is to apply for a 0% balance transfer. The only caveat is that many of these credit cards require a good-to-excellent credit score. The process of applying for a credit card involves a “hard credit pull” which actually inflicts damage on the credit score.  Also, Mary Ann informed me that she had a little over $700 in unpaid parking tickets that she only recently paid off.  These tickets may be a problem as they are most likely have adversely affected her credit score.  Also, if she can she’s better off applying for credit cards she’s been solicited or offered.  If there aren’t any attractive offers being made to Mary Ann currently, the following are all very attractive balance transfer credit cards with great promotional rates.

• Bank of America Platinum Plus 6 Month 0% APR, No Balance Transfer Fee, 11.24% APR
• Citibank Professional 0% Balance Transfer 12 Month, 11.74 APR, No Balance Transfer Fee (For Initial Offer)
• American Express Blue 4.99% Balance Transfer for Life, 3% Balance Transfer Fee
• Discover More 0% Balance Transfer for 12 Months, 3% Balance Transfer Fee, 10%-18.99 APR

I would also consult creditcards.com for a more comprehensive list of balance transfer offers. Even a credit card that has a balance transfer fee which typically run 3% of the balance transferred are a good deal given that Mary Ann’s paying over 3% every two months.

One of the real benefits of transferring credit card debt to another credit card via a balance transfer offer is that it’s absolutely free of most complications.  The minimum monthly payment should not go up, nor are there penalty rates once you go beyond the promotional period.  Yes, 18% is a penalty rate, but doing nothing at 20% is already a penalty.  Things can only get better except the credit score.

Even if your credit is good enough to qualify, often times the credit card companies do not give you enough credit to transfer the entire balance. Applying for multiple credit cards will hurt the credit score more, but if you’re not applying for a mortgage right now, taking a temporary hit to your credit score is OK. That said, credit scores affect many other things, too, such as insurance premiums.

If the balance transfer route doesn’t work out, there are still alternatives.

• Call your credit card company and try to negotiate a lower rate
• Apply for a loan on prosper.com, and get other people to bid on your loan. I would actually do this first, as you can set up a loan listing with very low interest rate (less than 6%) to get a vague idea of what your credit score is.  Once you know in what vague range your credit score you can better apply for the right credit card.  The alternative to getting graded on prosper.com is to get report from service such as www.freecreditreport.com. However those free credit scores online have many catches, and I generally advise against using them as they try to trap you into a credit monitoring service.

Prosper.com

I’m actually a lender on prosper.com, which, for people who haven’t heard of it, is a peer-to-peer lending website. Basically, I and other individuals collectively lend money to others who have made loan requests on the website. While I’m personally ambivalent about how well prosper.com works for lenders, I do think it can be a good opportunity for borrowers without other recourse to pay off high interest credit card debt. Not knowing exactly what Mary Ann’s credit score is, I’m not sure what kind of rate you can get on prosper.com. If I had to venture to guess, it would be in the 11%-17% range. These are not great rates, but it’s still better than 20%.

Currently, Mary Ann pays between $200-250 to her credit card each month. She’s been good and hasn’t been adding to the debt, but she does occasionally make a few transactions. I’m going to assume that $220 a month goes to servicing debt, i.e. paying interest ($87 a month) and paying down principal. Assuming that Mary Ann continues to apply the same amount to her payments, ideally, by doing a balance transfer or a combination of a balance transfer and a prosper loan, she can take some serious steps towards paying down her debt. After a year she can reduce her total balance owed by as much as $850 (using 0% balance transfer) without changing her monthly payments.

Once Mary Ann has figured out how much of her credit card debt she can transfer to a 0% APR offer or prosper.com, we should look at the bigger picture of both how much more she should be directing towards paying down her debt, and how she can do it if she can. Compared to many other Americans, she’s in pretty good shape.  Her fixed costs, rent and utilities, is on the low side, averaging about $650 a month or so. She has no other debt other than credit card, though beginning next year she will have about $27,000 in graduate school loans to repay.  Tomorrow we will look at next steps.