Baby Step 6 of Dave Ramsey’s Plan is to pay off your home mortgage early and be completely DEBT FREE. 

Similar to Baby Step 2, where you pay off all of your debts except for your home, you should use focused intensity and throw a good portion of your discretionary income (above your 15% retirement contribution and kid’s college funds) toward extra principal payments on your mortgage and knock it out as quickly as possible.  The more intense you become and the more that you are willing to sacrifice, the faster you will pay off your home.  As Dave says, when you own your home free and clear, if you take off your shoes and walk through the back yard, the grass will feel different under your feet.

There are some so-called experts out there who will tell you that it is not wise to pay off your home early.  They usually use one of two arguments to back their false cliams:

Argument #1:  Because mortgage rates are at an all-time low right now (4-5%), they say that you should keep your mortgage and invest your discretionary income in things that could earn you a higher rate of return like mutual funds and stocks.

Rebuttal #1:  They may be correct in their assertion that your could earn a higher rate of return in mutual funds and stocks, but they forgot to factor two things into their equation:  Risk and Taxes.

Risk comes when you still have a mortgage and your company downsizes.  Think about it…  If your company lays you off tomorrow and you have a paid-for house and no payments of any kind in the world, your stress levels would be completely different from someone who would immediately be worried about losing the home where their family sleeps at night.

Also, you will owe capital gains taxes if you invest in mutual funds or stocks and make a profit.  Capital gains taxes are around 15% for most people.

After factoring risk and taxes into the equation, your rate of return on that investment will come closer to the 4-5% that you would earn by not having a mortgage. 

Finally, if you are still not convinced that paying off your mortgage is a good idea, then ask yourself this question:  If you had a completely paid-for home, would you borrow money against it to invest in a mutual fund or the stock market?  If the answer to this question is “No”, then you should pay off your mortgage as quickly as possible and never look back!

Argument #2:  It is not wise to pay off your mortgage early because you will lose the tax deduction.

Rebuttal #2:  I have written a complete article about this argument.  Basically, with a tax deduction, for every dollar that you pay in interest to the bank, you save 25 cents on your taxes (this may be higher or lower depending upon your tax bracket) in the form of a tax deduction.  Trading whole dollars for quarters is unwise.  If you really want a tax deduction, then give the amount that you would be paying in interest to your local church or qualifying charity and you will earn the exact same tax deduction without having to stay in debt to do so.

My wife and I are set to start Baby Step 6 this year.  We are very excited about owning our home free and clear.  We can’t wait to walk through the back yard and see how different the grass will feel under our feet when it belongs to us and not the bank!

Baby Step 5 of Dave Ramsey’s Plan is to set aside some money for your child’s college education.  After Baby Step 4 is underway (saving 15% for retirement), you should set aside some money to help send your child to college.

If you have 5 years or longer until your child will be starting college, then you should invest the money in a good mutual fund inside of an ESA (Educational Savings Account) or 529 plan.  This will be after-tax money that is invested, but much like a Roth IRA, the money will grow tax free if it is used for your child’s college education.

The #1 goal is to not take out a student loan in order to send your child to college! The last thing that your child needs is to graduate from college with $100,000 in student loan debt hanging over his or her head.  This means that the choice of college is very important.  Unless your child receives an academic or athletic scholarship, then a state college should be the destination of choice.  Private schools are too expensive and, except in rare circumstances, employers really are not interested in where your child went to college.  Employers are interested in whether or not your child learned something while they were in college.

As your child approaches college age, he or she can assist with paying for college in a number of ways:

One way is by working full-time during the summer and a few hours per week during the school year.  Many people worked while attending school and you are not a child abuser if you insist that your child be one of them.

Another way is by maintaining a high grade point average and doing well on standardized tests like the SAT and ACT.  Be sure that your child enrolls in prep courses for the standardized tests that he or she plans to take.  Often, a high score on the standardized tests will open the door to scholarships that otherwise would not have been available.

If your child is a junior or senior in high school, a fantastic part-time job is for them to go online and use some of the search engines or purchase one of the computer programs that are available for finding scholarships.  Then, have your child to apply for each and every scholarship that they find.  This will include things like writing essays or submitting art portfolios (depending upon the type of scholarship sought), so it will keep the child very busy.  Dave Ramsey often recounts the story of a listener who purchased one of the computer programs that help find scholarships.  This listener applied for 1,000 scholarships and was turned down for all but 30 of them.  Those 30 scholarships netted her $38,000.  That is not bad for a part-time job!

If you have tried the methods above and you still don’t have enough money to send your child to college, then your child can do what millions of college graduates did…  Your child can work his or her way through college.  It will not kill them!

The most important thing to remember about funding your child’s college education is that you may find yourself in a financial position where you are not able to help your child pay for college.  Either your child is too close to college age or you are in really bad financial shape and you will not have made it to Baby Step 5 in time to help.  If this is the case, you are not a child abuser, so do not feel guilty!  You have kept a roof over your child’s head, clothing on his or her body, and food on the table.  Helping pay for college is at the bottom of the list until you get your own finances in order.  That’s why it is the 5th Baby Step behind paying off all debt except the mortgage, saving a 3 to 6 months of expenses for an emergency fund, and investing 15% of your income into retirement savings.

If, like my wife and me, you do not currently have any children, then you should skip this Baby Step.  Do not set aside college savings for children that you plan to have in the future.

Baby Step 4 of Dave Ramsey’s Plan is to invest 15% of your household income into Roth IRAs and pre-tax retirement plans.  At this point, because you have your Emergency Fund in place and are out of debt except for your home mortgage, you should easily be able to put away 15% for retirement.  Do not, however, put more than 15% into retirement at this Baby Step because there are still other Baby Steps to tackle first.

Dave recommends that you invest in 4 categories of mutual funds within your retirement plans:

Growth (Large Cap)
Growth and Income (Mid Cap)
Aggressive Growth (Small Cap)
International

Dave does not recommend that you ever invest in single stocks, bonds, commodities, CDs, or permanent life insurance, either inside of or outside of your retirement plans.

Because of different income levels or job benefits, not everyone has available all of the different types of retirement plans.  For example, if your income is too high, then you do not qualify to invest in a Roth IRA.  Likewise, your company may not offer a pre-tax retirement plan like a 401(k) or 403(b).  However, if you have both types of retirement plans available to you, then Dave recommends that you invest in them in this order:

Pre-Tax Retirement Plan With Company Match: If your company matches any portion of your savings into a pre-tax retirement plan, then you should invest enough to get all of the match that they offer.  Most companies match between 3-6% of employee contributions.

Roth IRA: Currently, the limits for Roth IRA contributions are $5,000 for an individual or $10,000 for a married couple who files a joint tax return.  Invest into your Roth until either you reach 15% of your income, or until you max it out, whichever comes first.

Pre-Tax Retirement Plan Without Company Match: If you have invested enough in your pre-tax retirement plan to get all of the match that your company offers and then you have maxed out your Roth IRA for the year and you still haven’t reached 15% of your household income, then you should go back and top off your retirement savings in your pre-tax retirement plan until you reach a total of 15% of your income.

As an example of how to determine the order of priority for your retirement investing, assume that your situation matches the profile below:

Household Income:  $100,000
Retirement Contribution for Baby Step 4:  $15,000 ($100,000 x 15%)
Company Offers Pre-Tax Retirement Plan with 3% Match
Married Filing Jointly

You should invest $3,000 ($100,000 x 3%) into the Pre-Tax Retirement Plan in order to take advantage of the company match.  That leaves $12,000 to be invested.

Next, open two Roth IRA accounts (one for each spouse) and max them out for the year by investing $5,000 in each one for a total of $10,000.  That leaves $2,000 to be invested.

Finally, return to your Pre-Tax Retirement Plan and invest the remaining $2,000.

When my wife and I arrived at Baby Step 4 in Spring 2009, we scheduled an appointment with one of Dave Ramsey’s ELP’s (Endorsed Local Providers) for Investing.  There was no charge to meet with them and there was no pressure to buy anything.  They explained all of our options with the heart of a teacher, and worked with us to select mutual funds with low expense ratios and long track records of great returns.  We opened our two Roth IRAs that day and have been very pleased with the results.

My company matches 6% of our 401(k) contributions, so we already had 6% going into that.  After maxing out the Roth IRAs, we added another 2% to my 401(k) to reach our 15% goal.

Investing for retirement can be a very complicated matter because of all of the choices out there.  Be sure to visit daveramsey.com for more information about Dave’s Investing Philosophy.

Baby Step 3(b) is an official part of Dave Ramsey’s Plan, but it is never included in Dave’s list of Baby Steps.  If you listen to the Dave Ramsey Show, people call in all the time who are working the plan and they ask questions like, “When is it OK to purchase another car?” or “Our washing machine is on it’s last legs, when can I purchase another one?” or “When can we take a vacation?”

Dave always says that these things are part of Baby Step 3(b).  Translated, this means that when you are debt free except for your home mortgage (Baby Step 2) and have 3-6 months of expenses set aside as a fully-funded Emergency Fund (Baby Step 3), you are then ready to replace those things that you have let slide during the first 3 Baby Steps.  This can also include a few small luxury items like a reasonable vacation or a new HDTV, but the items that you purchase in this step should mostly be necessities and the list should be small.

Be warned, however, that this can be a very dangerous Baby Step!  When you get here, it usually means that you have sacrificed for 2 or 3 years to get your finances in order.  Perhaps you are driving a beater car or haven’t been on a real vacation during that time.  It would be very easy to go on a spending spree with your newly freed-up income, but you really need to make some tough decisions about exactly what you need to do at this step and what can wait until other Baby Steps have been completed. 

The way to do this is to sit down with your spouce and write out a list of your Baby Step 3(b) goals that you both agree upon and, then, when those goals have been met, move on to Baby Step 4.

After our fully-funded Emergency Fund was in place in late 2008, my wife and I saved up and replaced both of our vehicles in early 2009.  She was driving a 2000 Nissan Frontier and needed a smaller, 4-wheel drive vehicle for her work.  I was driving a 1998 Pontiac Grand Prix with 240,000 miles on it.  We saved up and paid cash for new (to us) cars.  She got a 2002 Subaru Outback Legacy wagon and I got a 2008 Pontiac Grand Prix.  It was a lot of fun saving up and being able to write a check to purchase vehicles.  They really do drive a lot better when they aren’t towing around a payment book!

Baby Step 3 of Dave Ramsey’s Plan is to raise your Starter Emergency Fund until it contains 3-6 months of expenses.  Now that you are debt free except for your home mortgage (if you have one), take all of the payments that you were making toward credit cards, student loans, and car payments and throw it into your Emergency Fund until you get 3-6 months worth of expenses saved up.  According to Dave Ramsey, 3-6 months of expenses represent between $10,000 and $15,000 for most households. 

Unlike the $1,000 that you saved for Baby Step 1, you will not want to keep this in cash.  Instead, you should keep your Emergency Fund in something like a Money Market account that has check writing and/or check card privileges or a basic savings account.  The key is to have quick and easy access to the money with no penalties for withdrawal.  Therefore, you would not use a CD (Certificate of Deposit) for your Emergency Fund because there are penalties for early withdrawal.

Remember, also, that you should not be concerned with the interest rate of your Emergency Fund account.  The Emergency Fund is not an investment.  It is insurance against life’s unexpected events that could not be budgeted for in advance.

After you have completed your Emergency Fund, DO NOT TOUCH IT…  except if you have an unexpected event that leaves you with no other options.  A new HDTV IS NOT an emergency!  Neither are automobile repairs.  If you follow Dave’s budget forms, then you would realize that Auto Repairs is a standing category and you should save for them all along in a separate slush fund.

In our situation, my wife was comfortable with $10,000 in the Emergency Fund.  I wanted $20,000.  We compromised and settled on $15,000.  It is in a Money Market account with a large national bank and, currently, earns about 1.5% interest.  Again, interest rate does not matter here, but I wanted to let you know what to expect.

If you are a follower of Dave Ramsey’s plan and you have gotten through Baby Step 3, take a deep breath and pat yourself on the back.  You are debt free except for your mortgage and you have $10,000-$15,000 in the bank.  Life is pretty good on the planet when you first get yourself in this position.  Realize that you are now way ahead of most of your neighbors, friends, co-workers, and family members financially.  Congratulations!

I’ll begin by stating that this site is in no way affiliated with Dave Ramsey or his company, The Lampo Group.  We are simply thankful to Dave and his team for putting out the valuable information that has allowed literally millions of families to change their financial futures.

In July 2003, I was scrolling through the channels of my new Sirius Satellite Radio while out running errands and I stumbled across this crazy guy on the Sirius Talk channel.  The guy was explaining to a caller how the caller could pay off $12,000 worth of debt in less than one year.  During the 5 minute conversation, the radio host laid out a game plan for the caller and walked him through a process of getting out of debt and building wealth called The Baby Steps. (Later, I would find out that Dave borrowed the term “Baby Steps” from Richard Dreyfuss’s character in the film What About Bob?)

Not counting our home, my wife and I were in 6 TIMES as much debt as the caller that day, but that moment planted a seed of hope in my mind.  The first thing I did was write down the name of the radio show host…  Dave Ramsey.  When I returned to work, I searched Google for Dave Ramsey and came to his website.  There was a wealth of information to be had from that site and most of it was free.

I went home and told my wife about hearing Dave Ramsey on the radio.  She was excited about trying the plan, so we ordered his book, Financial Peace Revisited, and two audio CDs, Cash Flow Planning and Dumping Debt.  Those were the actions that would permanently change our financial future.

In the days leading up to August 1, 2003, my wife and I read the book and listened to the CDs.  We then sat down and, using a yellow pad, we wrote out our very first budget.  There were squabbles and doubts and serious discussions, but we managed to get it all down on paper and to agree on the amounts in each category.

On August 1, 2003, we put our first budget to work for us and started our own path down Dave Ramsey’s Baby Steps.  Here now are those steps:

• Baby Step 1: Save $1,000 cash into a Starter “Baby” Emergency Fund.
• Baby Step 2: Pay off all of your debt, except for your home, using the Debt Snowball.
• Baby Step 3: Raise Your Starter Emergency Fund From $1,000 Until It Contains 3-6 Months of Expenses
• Baby Step 3(b): Take a Short Breather and Replace That Beater
• Baby Step 4: Invest 15% of Your Household Income Into Roth IRAs and Pre-Tax Retirement Plans
• Baby Step 5: Save for your child’s college education
• Baby Step 6: Pay off your home early
• Baby Step 7: With no payments left, there is nothing left to do but build up wealth and give a lot of it away.

In the coming days, I will go over each Baby Step in detail and describe our experiences, mostly good but there were some challenges, as we walked down the path to our current step, Baby Step 6.