No More Debt, in theory and in practice

A few weeks ago Darwin's favorite economics podcast, EconTalk, featured Megan McArdle, a libertarian blogger he reads frequently. The topic was Debt and Self-Restraint, and a good portion of the podcast was devoted to McArdle discussing how she'd worked out of debt by establishing a budget, using cash instead of credit cards, and paying off loans as fast as possible. Of course these are pretty basic principles, McArdle allowed, but "pretty basic" does not translate into "universally followed". Even we, who consider ourselves basically financially savvy, found ourselves writhing guiltily as we pondered our lack of firm budget and our reliance on credit cards as our normal financial tool.

McArdle had been inspired to financial self-control while researching Dave Ramsey for an article she wrote for The Atlantic. We had never heard of Dave Ramsey, but it seems he's a financial guru with a radio following of 3 million listeners. So we bought Ramsey's latest book The Total Money Makeover (on Amazon, using a credit card), and read and discussed it over the holidays. In the book Ramsey says that people tell him that his book was the first one they'd read in ten years, and (to be honest) it does read rather at that level, but his process in a nutshell is:

1. Quit using credit cards
2. Make a budget in which every last dollar of income is accounted for.
3. Save $1000 as an emergency fund.
4. Start paying down debt (except your mortgage) with every extra dollar, starting with your smallest debt. Pay the minimum on all other debts.
5. As you pay off a debt, roll that money into paying off your next smallest debt.
6. Once your debt is paid, save a larger emergency cushion, perhaps equal to three months income.
7. Pay off your mortgage at an accelerated rate.
8. Invest, Give, and Have Some Fun with your money.

Our debt, we thought, lay in four categories: Student Loans, Mortgage, The Van, and The Dryer. In an act of self-delusion, perhaps, we never considered ourselves in credit card debt because we pay off our card each month. But, as we contemplated moving to an all-cash system, we had to confront what we knew intellectually but hadn't considered practically: that, if you pay your card on the due date each month, you're really two months in arrears. You have the month you're currently spending on, and the previous month for which you have the statement and the bill. This works out fine if you intend to keep paying your statement balance every month, but if (as we have for years) you do all your spending on the card, then when you decide that you want to switch to an all-cash economy you're faced with, well, debt.

So. Today is the first payday of the new year, and it's the day for the switch. We plan to follow Ramsey's basic outline, except that we're not going to pay down the smallest debt (the dryer -- which is at zero interest for another 8 months anyway) first. First, we're going to get out of credit card debt.

UPDATE: (A word from Darwin) The really tough thing, contemplating all this, has been accepting the idea of ceasing to use the credit card, going to an all cash budget, and then paying off the credit card over a series of months as a debt. I don't think I'd realized up until I contemplated this how much of my pride is wrapped up in the words "I don't carry a balance." Sure, at several points in our marriage, after a major expense (giving birth, etc.) we'd carried a credit card balance for a couple months, but in each case we'd budged very aggressively until we were back to paying off the entire credit card every month. I drew a lot of pride and satisfaction from thinking (when I read about how the average household carried 10K+ in credit card debt) "But we don't have a problem, we don't carry over a balance." thus putting ourselves in the group who cash in credit card rewards (in our case, we get Amazon gift certificates equal to 1% of our purchases) while never paying interest or fees.

The kicker, however, was realizing that if we ever had a major financial emergency (like if I lost my job) we'd have between one and two months complete spending already out there. Suddenly we'd be carrying a pretty substantial balance. And so we gritted our teeth and made the decision to step off the carousel voluntarily now, rather than finding ourselves pushed off at a time when it would represent a major crisis rather than a budgeting choice.