The Total Money Makeover: Classic Edition

by Dave Ramsey

  If you walk your way up these Baby Steps, you can send your kids to school without debt. Even if you start late, perseverance and resourcefulness can get them through school. If you want to go to college badly enough in America today, you can. The good news is that those of you who have a Total Money Makeover will likely not only pay for your child’s education, but also—by teaching your children to handle money, and by becoming wealthy—your grandchildren can go to school debt-free.

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  Pay Off the Home Mortgage: Be Ultra-Fit

  I have a good friend who runs a lot of marathons. I sit and listen in awe to the stories of all the marathons he has run. I am amazed by the dedication, training, and pain marathoners embrace. I have personally run one full marathon, and I enjoy doing several half marathons a year, but these folks who do multiple marathons every year are some of the fittest people in the world. As you reach Baby Step Six, you reach marathoner status in the wealth-building world. You have run the good race, but you aren’t done.

  Bruce, my marathon friend, told me (and I experienced it too) that at about the 18-mile mark (out of 26.2), runners begin to lock up. Some really nasty things start to happen to your muscles and your mind at that point. You’re almost through the race and nothing wants you to finish. The highly trained and conditioned body starts talking to you about stopping. Big black clouds of doubt enter the mentally tough and trained competitive mind. You begin to think things like, Eighteen miles is pretty good; few others could accomplish that. If you aren’t really careful, “The Good Enough” can become the enemy of “The Best.” “Bad” is seldom the enemy of “The Best,” but mediocrity with a dose of doubt can keep you from excellence. Finishing well can be more important than starting well.

  Reach for the Gold Ring

  At this point in your Total Money Makeover, you are debt-free except for the house, and you have three to six months of expenses ($10,000+/–) saved for emergencies. At this point in your Total Money Makeover, you are putting 15 percent of your income into retirement savings and you are investing for your kid’s college education with firm goals in sight on both. You are now one of the top 5 to 10 percent of Americans because you have some wealth, have a plan, and are under control. At this point in your Total Money Makeover, you are in grave danger! You are in danger of settling for “Good Enough.” You are at the eighteen-mile mark of a marathon, and now that it is time to reach for the really big gold ring, the final two Baby Steps could seem out of your reach. Let me assure you that many have been at this point. Some have stopped and regretted it; others have stayed gazelle-intense long enough to finish the race. The latter have looked and seen just one major hurdle left, after which they can walk with pride among the ultra-fit who call themselves financial marathoners. They can count themselves among the elite who have finished The Total Money Makeover.

  We started Dave’s plan for a Total Money Makeover in 2002 with over $3,000 in a home equity loan, credit-card bills, a $30,000 mortgage, and no emergency fund or savings. We were living on about $45,000 and felt out of control. When we learned about the Baby Step process, we knew that it was the best way out. We started working through the Baby Steps as quickly as we could, and our lives began an immediate change.

  We knew we had to first get on a budget and get that Debt Snowball going. The best way to jump-start things was to have a garage sale. It was great! We made over $500 and paid off quite a few bills immediately. We continued to work and save and work some more. We were determined to beat the system and press forward. We paid off the consumer debt, fully funded our emergency fund, and started investing. We were amazed with how focused we had become on getting completely out of debt.

  But we didn’t stop there—the ultimate challenge was to pay off the house. This was one of the most challenging things I’ve ever done in my whole life. I got a second part-time job cleaning offices thirty hours a week in addition to working full-time. Joe worked overtime seven days a week. For five grueling months we worked harder than we ever had in our entire lives, but we knew that it was worth it. And then, finally, in September of 2005, we reached our goal. We paid off our house, making us completely DEBT-FREE!!!

  It’s unbelievable the feeling of freedom that comes when you don’t have the weight of payments hanging over your head. We can now focus on saving for retirement entirely and start really living! I even got to quit my job and start my own business so I don’t have to go to a dreaded J-O-B every day; I get to do what I love. Good things really do come to those who wait.

  God has definitely blessed us through this experience. For the first time, our future plans won’t just seem like a dream, but we can make them a reality. If we can do this, anyone can!

  Carla (age 38) and

  Joe (age 43) Schubeck

  Designer/Minister; Press Operator

  Baby Step Six: Pay Off Your Home Mortgage

  The final hurdle before you turn the corner for the last few miles is to become completely debt-free. No payments. How would it feel to have no payments? I have said it before, and I will repeat myself until you hear me: if you invested what you pay in monthly payments, you’d be a debt-free millionaire before long. Your largest wealth-building tool is your income; you have read that over and over. Now you get to see the possibilities unfold. You have trained, conditioned, and eaten right to run this marathon, so don’t quit on the eighteenth mile! Every dollar in your budget that you can find above living, retirement, and college should be used to make extra payments on your home. Attack that home mortgage with gazelle intensity.

  My family has a fabulous dog, a Chinese pug, a dog like Frank in the Men in Black movies. Her name is Heaven, and when we talk to her, she cocks her little round head sideways in a questioning look as if we have lost our minds. If you heard the way we talk to the dog, you might think we really had lost our minds. We have all seen the cocked-sideways look coming at us when we have said something weird, something against the culture. When I say, “Pay off the mortgage,” some of you look at this book as if I had told you to build wings and fly to the moon.

  Anytime I speak about paying off mortgages, people give me that special look. They think I’m crazy for two reasons. One, most people have lost their hope, and they don’t really believe there is any chance for them. Two, most people believe all the mortgage myths that have been spread. Yes, we must dispel a few more myths. There are two really big “reasons” that keep seemingly intelligent people (like me for years) from paying off mortgages, so we will start with those.

  Remember, Beware of the Myths

  Big Reason Number One:

  MYTH: It is wise to keep my home mortgage to get the tax deduction.

  TRUTH: Tax deductions are no bargain.

  We discussed tax-deduction math when we looked at car fleeces. Let’s review. If you have a home with a payment of around $900, and the interest portion is $830 per month, you have paid around $10,000 in interest that year, which creates a tax deduction. If, instead, you have a debt-free home, you would, in fact, lose the tax deduction, so the myth says to keep your home mortgaged because of tax advantages.

  This situation is one more opportunity to discover if your CPA can add. If you do not have a $10,000 tax deduction and you are in a 30 percent bracket, you will have to pay $3,000 in taxes on that $10,000. According to the myth, we should send $10,000 in interest to the bank so we don’t have to send $3,000 in taxes to the IRS. Personally, I think I will live debt-free and not make a $10,000 trade for $3,000. However, any of you who want $3,000 of your taxes paid, just e-mail me and I will personally pay $3,000 of your taxes as soon as your check for $10,000 clears into my bank account. I can add.

  DAVE RANTS . . .

  If you get a big tax refund, you’ve just allowed the government to use your money interest-free for one year.

  Big Reason Number Two:

  MYTH: It is wise to borrow all I can on my home (or continually refinance for cash out) because of the great interest rates; then I can invest the mo
ney.

  TRUTH: You really don’t make anything when the smoke clears.

  This one is a little complicated, but if you follow me, you will have intellectually grasped why so many people have fallen into a financial pit. The myth that I was taught in academia (I am not against higher learning, by the way, as long as we are learning the truth) is to use lower-interest debt to invest in higher-return investments. Sadly, some “financial planners” have told Americans to borrow on their homes at around 8 percent to invest in good growth-stock mutual funds averaging 12 percent because you make an easy 4 percent spread.

  Mutual funds are awesome investments, and as I have said, I personally have tons of money invested in good growth-stock mutual funds. Also, the stock market has averaged around 12 percent from the beginning. Some years are great and some are lousy, and we have had both in the last ten years, but the long-term average is around 12 percent. So I buy and recommend mutual funds.

  The problem with this myth is that the assumptions used to get to that 4 percent spread or profit on investing are wrong. Mythsayers, and I have been one, are very naïve in how they approach investing.

  Let’s look at borrowing $100,000 on your home to invest. If you borrowed at 8 percent, you would pay $8,000 in interest, and if you invested the $100,000 you borrowed on your home and made 12 percent, you would make $12,000 in return, netting you $4,000. Or would you? Where I live, if you make $12,000 on an investment, you will pay taxes. If you are in a 30 percent bracket, you will pay $3,600 in taxes at ordinary income rates or $2,400 if you invest at capital gains rates. So you will not net $4,000, but instead $400 to $1,600. But we aren’t through yet.

  If I own the home next to you and have no debt, and you (because of your investment adviser guy) borrowed $100,000 on your home, who has taken more risk? When the economy moves south, when there is war or rumors of war, when you get sick or have a car wreck or are downsized, you will run into major problems with a $100,000 mortgage that I will never have. So debt causes risk to increase.

  I can prove to you that risk increases. With the drop in real estate values and the slowing market in the 2008–09 recession, many people lost their homes to foreclosure. I have done in-depth, detailed research and have found that 100 percent of the foreclosed homes had a mortgage. Ha! Sadly, some of the people who lost their homes had a naïve financial planner who left risk out of his formula and suggested they “harvest” their equity. Like I said earlier, “When the tide goes out, you can tell who was skinny-dipping.”

  Since debt causes increased risk, we must mathematically factor in a reduction in return if we are sophisticated investors. If you can make 12 percent on a mutual fund, and I try to get you to invest in a bet on the roulette wheel, which will return you 500 percent, you would automatically say the two don’t compare. Why? Risk. Common sense tells you not to compare mutual funds and roulette wheel returns without adjusting the returns for risk. Common sense tells you to discount the 500 percent upside of the roulette wheel because of risk. After discounting the roulette wheel for risk, you would rather have the mutual fund. Good choice.

  Actually, this is done in academia as well. There is a statistical measure of risk called a beta. A big beta means a big risk. Graduate-level financial people who are taught mathematical formulas to make risky investments compare apples to apples with safer investments after adjustment for risk. We just never apply that formula to a debt-free home versus a mortgaged and invested home, which is very naïve. The technical formula is great for putting you to sleep, but understand that you can’t compare risk with no risk unless you make adjustments.

  The bottom line is that after adjusting for taxes and risk, you don’t make money on our little formula. Throughout a lifetime of investing and mortgaging, the debt-free person will actually come out ahead.

  MYTH: Take out a thirty-year mortgage and promise yourself to pay it like a fifteen-year, so if something goes wrong you have wiggle room.

  TRUTH: Something will go wrong.

  One thing I am sure of in my Total Money Makeover: I had to quit telling myself that I had innate discipline and fabulous natural self-control. That is a lie. I have to put systems and programs in place that make me do smart things. Saying, “Cross my fingers and hope to die, I promise, promise, promise I will pay extra on my mortgage because I am the one human on the planet who has that kind of discipline,” is kidding yourself. A big part of being strong financially is that you know where you are weak and take action to make sure you don’t fall prey to the weakness. And we ALL are weak.

  Sick children, bad transmissions, prom dresses, high heat bills, and dog vaccinations come up, and you won’t make the extra payment. Then we extend the lie by saying, “Oh, I will next month.” Grow up! Research has found that almost no one systematically monthly pays extra on their mortgage; you simply can’t kid yourself.

  Shorter Terms Matter

  Purchase Price

  $250,000

  Down Payment

  $ 25,000

  Mortgage Amount

  $225,000

  At 7% Interest Rate

  30 Years

  $1,349

  $485,636

  15 Years

  $1,899

  $341,762

  Difference

  $550

  $143,874

  Five hundred fifty dollars more per month, and you will save almost $150,000 and fifteen years of bondage. The really interesting thing I have observed is that fifteen-year mortgages always pay off in fifteen years. Again, part of a Total Money Makeover is putting in place systems that automate smart moves, which is what a fifteen-year mortgage is. Thirty-year mortgages are for people who enjoy slavery so much they want to extend it for fifteen more years and pay thousands of dollars more for the privilege. If you must take out a mortgage, pretend only fifteen-year mortgages exist.

  If you have a great interest rate, it is not necessary to refinance to pay a mortgage off in fifteen years or earlier. Simply make payments as if you have a fifteen-year mortgage, and your mortgage will pay off in fifteen years. If you want to pay any mortgage off in twelve years or any number you want, visit my website or get a calculator and calculate the proper payment at your interest rate on your balance for a twelve-year mortgage (or the number you want). Once you have that payment amount, add to your monthly mortgage payment the difference between the new principal and interest payment and your current principal and interest payment, and you will pay off your home in twelve years.

  The best time to refinance is when you can save on interest. Use the calculators on my website at daveramsey.com/tools to determine whether you should refinance. When refinancing, paying points or origination fees are not in your best interest. Points or origination fees are prepaid interest. When you pay points, you get a lower Annual Percentage Rate (APR) because you have already paid some of the interest up front. The math shows that you don’t save enough on interest rates to pay yourself back for the points. When you pay points, you are prepaying interest, and it takes an average of about ten years to get your money back. The Mortgage Bankers Association says the average life of a mortgage is only about three to five years, so on average you don’t save enough to get your money back before you pay the loan off by moving or refinancing. When refinancing, ask for a “par” quote, which means zero points and zero origination fee. The mortgage broker can make a profit by selling the loan; they don’t need the origination fee to be profitable.

  MYTH: It is wise to use the lower rates offered by an ARM mortgage or balloon mortgage if you know you’ll “be moving in a few years anyway.”

  TRUTH: You will be moving when they foreclose.

  The ARM, Adjustable Rate Mortgage, was invented in the early 1980s. Prior to that, those of us in the real estate business sold fixed-rate 7 or 8 percent mortgages. What happened? I was there in the middle of that disaster of an economy when fixed-rate mortgages went as high as 17 percent and the real estate world froze. Lenders paid out 12 percent on CDs but had
money loaned out at 7 percent on hundreds of millions of dollars in mortgages. They were losing money, and lenders don’t like to lose money. So the Adjustable Rate Mortgage was born, in which your interest rate goes up when the prevailing market interest rates go up. The ARM was born to transfer the risk of higher interest rates to you, the consumer. In the last several years, home mortgage rates have been at a thirty-year low. It is not wise to get something that adjusts when you are at the bottom of rates! The mythsayers always seem to want to add risk to your home, the one place you should want to make sure has stability.

  Balloon mortgages are even worse. Balloons pop, and it is always strange to me that the popping sound is so startling. Why don’t we expect it? It is in the very nature of balloons to pop. Wise financial people always move away from risk, and the balloon mortgage creates risk nightmares. When your entire mortgage is due in thirty-six or sixty months, you send out engraved invitations for Murphy (Remember him? If it can go wrong, it will) to live in your spare bedroom. I have seen hundreds of clients and callers like Jill over the years.

  Jill is the wife of a sophisticated, upwardly mobile corporate guy. Her husband assured her they would be moving up because his career was on the fast track. So they got the lower interest rate and took a five-year balloon. “We just knew we would move inside five years,” she said. Her husband began having headaches in the third year of the mortgage, which, sadly, they discovered were caused by a brain tumor. We met this upwardly mobile corporate executive with limited speech and in a wheelchair, totally and permanently disabled at thirty-eight years of age. His life had been spared, but the surgeries had devastated him. Jill, now a middle-aged mom of two with a disabled husband, didn’t have the income to refinance the home when the balloon came due.