Next steps

Since becoming debt free, I’ve had two questions come up regularly by people I know and readers of this site. One of the questions I’ll address in another post, but this post is about the other question I’ve heard a lot: “Now that you’ve paid off your debt, what will you do next?”

My family is following Dave Ramsey‘s baby steps plan for our finances. In Baby Step 1, cultists followers save $1,000 — and only $1,000 — as a type of baby emergency fund to take care of problems that could arise while working the way out of debt. I have found that this step is often the most misunderstood of all the steps.

Yes, $1,000 isn’t enough to cover a major emergency. If something goes wrong that means you have to get pretty creative in figuring out how you can overcome the obstacle without going deeper in debt if possible. This is a difficult feat, and I’ll be the first to admit that for some major emergencies, you might end up with an expense that cost more than $1,000. But our experience has proven that most of life’s emergencies can be covered with $1,000 or less. In those cases, you use your baby emergency fund, press pause on paying more on the debt, and then rebuild the $1,000 as quickly as possible.

This baby emergency fund is not supposed to make you feel comfortable. In fact, it’s quite the opposite. It serves as a kind of cushion between you and minor emergencies, while also making you feel the pressure to quickly get out of debt so you can move on to a more robust emergency fund. I’ll cover that in a minute.

In Baby Step 2, you are supposed to go kind of insane. You buckle down, get really serious about paying off the debt, and then list all your debts from smallest to largest regardless of the interest rate on each debt. So, if you had $5,000 in credit cards, a $400 line of credit at the furniture store, student loans of $40,000, and a car loan of $10,000 the debt payoff would look like this:

  1. Line of credit: $400
  2. Credit cards: $5,000
  3. Car loan: $10,000
  4. Student loans: $40,000

This method is called the debt snowball, because once you pay the smallest loan with everything you have and then make the minimum payments on the rest. Once a debt is gone, you take what you were paying on that debt, and then apply it and any other money to the next debt. You keep going up the list until everything is paid.

I know what you’re thinking: it doesn’t make mathematical sense to disregard the interest rates and do it that way. However, the psychological wins you get from the debt snowball gaining momentum helps to keep you moving forward. And as Ramsey likes to say, “If we were doing math we wouldn’t be in this mess to begin with.”

So now that we’re here, what do we do now? Now we’re on to Baby Step 3.

In this step, we save three to six months of expenses — a real, actual, grown up emergency fund.

Whether you decide on three months or six months is more of a personal choice. Do you have a steady job that you feel has a reasonable expectation of being there for awhile? Do you have a household where both spouses work? In those cases, you might be fine with three months of expenses. Is your job volatile? Are you working on a contract basis or self employed? Then you might want to shoot for six months of expenses. It’s really up to you.

The great thing is that once all your debt is paid off, your monthly expenses will go down quite a bit. You end up needing less to sustain you in a Big Hairy Emergency. That’s where we are. We’re now in Baby Step 3, moving forward with socking money away for a potential emergency, which I promise you will come eventually.

I can’t think of a time in my adult life when we have had an actual emergency fund. Sadly, I can think of plenty of times where we have needed one, which ended up being handled with adding more debt rather than taking on extra jobs or working with service providers to get a payment plan figured out.

After we made our final debt payment, I was thrilled. However, since then I’ve felt a little lost. The process was such a huge part of our lives for awhile and now it’s … over. It sounds strange, but it’s almost like losing an old friend (even if it was one that I didn’t really like).

So now the challenge is this: we need to keep our intensity up. Now is not the time to start spending like crazy people. We’re still in The Year of No, but instead of our money going to some other bank, it’s now coming back to us. The danger is the possibility of lost intensity, but we will keep pressing on to our next goal.

Getting out of debt isn’t the end. In fact, it’s only the beginning.

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