When your budget won't let you give gifts to everyone in the world—which is always, by the way—who should you give...
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It's the Baby Step that Dave is best known for ... Baby Step 2, where you employ the debt snowball to give your debt the beatdown.
But wait, you may say. What if I'm investing for retirement? Do I need to stop that? How do I know if I should sell one of my cars? There are a number of questions like these that people have when they start the payoff process, and we've got you covered.
Why pay the smallest debt first, instead of the one with the high interest rate?
The point of the debt snowball is behavior modification. If you pay on a student loan first because it's the largest debt, you won't see it leave for a while. You'll see numbers going down on a page, but that's it. Pretty soon, you'll lose steam and stop paying extra, but you'll still have all your debts hanging around.
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But when you ditch the small debt first, you see progress. That one debt is out of your life forever. Soon the second debt will follow, and then the next. When you see that the plan is working, you'll stick to it. By sticking to it, you'll eventually succeed in becoming debt-free!
How do I know when to sell something or pay it off?
A general rule of thumb is this: If it will take you more than 18 to 24 months to be debt-free on an item, sell it. If you are making $500 monthly payments on your car and it will be another three years before it's paid off, get rid of it. The impact of freeing up that monthly money, plus not owing a huge car balance, will rock your world.
The same rule goes for boats, rental properties, and anything else except for your home. Being free of the payment will drastically help your mindset and your wallet as you break the chains of debt. But if you own a motorcycle that will be paid off in a few months, it's all right to keep it. Just get rid of the debt on it!
Should I keep saving for retirement while in Baby Step 2?
No. You want to commit all your energy and resources to getting out of debt while on Baby Step 2, and diverting money toward retirement savings means you'll stay in debt longer. Don't dilute your efforts; concentrate on one thing at a time.
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Even if you get a company match, don't take it while you're eliminating your debts. With a cut lifestyle, extra income from a second job (if you take one) and super focus, you'll get out of debt quickly and establish your full emergency fund. Then you can go right back to investing. Being debt-free will more than make up for taking a year or two off of investing.
What if a baby is on the way?
First off, congratulations! A baby is always cause for celebration. What you want to do if you're expecting is to stop the debt snowball and pile up cash. Keep making your minimum payments, but stock away all the remaining money. If an emergency happens and there are medical bills, then you have the money there to take care of them.
Once your new bundle of joy is home from the hospital and everyone is all right, then take your saved-up money and apply it to the debt snowball.
What if I get laid off while paying off?
That's scary to think about, but if you lose your job, go into survival mode. Make sure your lifestyle is slashed to the basics. Keep making your minimum payments, but no extra ones. Stop the debt snowball until you find work again (and get a job delivering pizzas or some other work until you land a full-time position with another company).
If you get severance pay, don't kick back and live off of that. Try not to even touch it. Live bare bones and hunt like crazy for work. The sooner you get a new job, the sooner that severance looks like a huge bonus that you can apply toward the debt snowball.