We’ve mentioned a few times that we loosely follow the Dave Ramsey 7 Baby Steps. We say ‘loosely’ because living in the UK means we do things slightly differently. We have been asked a few times now to explain what the 7 baby steps are, so we’ve decided to do explain each Baby Step, and how we apply them in the UK.
In this post, I will start by explaining Dave Ramsey’s Baby Steps 0 to 3b, applied to the UK market.
Who is Dave Ramsey?
Before we jump into the baby steps, we thought we should explain who Dave Ramsey is! Dave Ramsey is a personal finance expert from the United States. He gained a lot of his financial knowledge through becoming bankrupt and struggling with debt himself. He then rose to financial “stardom” due to his debt management expertise and his famous “Ramsey Baby Steps”.
What are the 7 baby steps?
The 7 baby steps are guidelines created by Dave Ramsey to help people get their personal finances in order. They are a series of small financial goals that help you achieve financial stability and lay the foundations for you to build wealth.
Baby Step 0
Baby Step 0 is often overlooked in many explanations of the steps. It is essentially getting up to date on all your bills. You shouldn’t even think about any of the other Baby Steps until you are on top of your current outgoings and are out of our overdraft.
In this step, we need to think about our 4 walls (which can be compared to Maslow’s hierarchy of needs)
- Food-above all else: before we do anything else, we need to feed ourselves and our families.
- Shelter (rent or mortgage): We also need somewhere to live.
- Utilities: we need to have lights, heating and electricity.
- Transport: if we need to get to work then we need to think about this as it is crucial to making a living.
Then, we get current with things like credit cards, loans, and paying off debts before we start the Baby Steps. So, we are covering our 4 walls, and paying the minimums on all our debts.
The aim is for us to get (and stay) current all the way through paying off the Baby Steps. Before we start Baby Step 1, I think it’s very important to have written a budget.
Baby Step 1
Baby Step 1 is the starting point to your financial plan. It is to save £1,000 cash in the bank. Or if your household income is less than £20k a year, that amount is reduced to £500.
This is our Baby EF (Emergency Fund). Now, don’t panic. Later in the Baby Steps, we will come back to this ‘Baby EF’ and add more money to it, but right now, we just need to focus on saving that £1000/£500.
The aim is to save this money as quickly as possible so that we can move on to the next step. So, we can sell any unwanted or unnecessary items that we have in our home (clothes, furniture, shoes, music equipment, ANYTHING goes) or cut out anything we can from the budget (therefore, I feel it’s crucial to have written a budget before you start this step).
Be lethal. As Dave Ramsey himself says, “sell so much stuff that the kids think they’re next!”.
Why have an Emergency Fund?
According to The Money Charity, around 9.45m (35%) of UK households have no savings whatsoever. That is a scary thought, that 35% of households in the UK don’t have any savings for emergencies.
As you can probably tell from its name, the Emergency Fund is ONLY for emergencies. Things that we cannot see coming and unexpected life events. It is not for things like Christmas, Birthdays, Days out etc.
The fact is, that unless we have an emergency fund to cover emergencies, we WILL end up getting into more debt than we currently have. Life happens, and we need to be prepared for it.
Imagine that you lost your job, or that your car was in an accident, or you had an urgent plumbing problem in your house. Without an emergency fund, how are you going to pay for the expenses that will occur? Well, if we don’t have the cash to pay for it, we’ll end up using a credit card, a type of loan, or other forms of debt. When we have an emergency fund, we have that small safety net.
Baby Step 2
Onto Baby Step 2. This is probably the most exciting of the Baby Steps – paying off all of your debt except your mortgage.
So, you start Baby Step 2 by writing down all of your debts in order from smallest to largest. For many people, this is the hardest part of the whole journey. You see how much you actually owe. I found it very eye-opening and it made me want to run in the opposite direction.
But once we get through that part, and face it, we have the motivation to start paying it off. You can read how we stayed motivated when paying off debt here.
What is the snowball method?
To pay off the debt, you’ll be using The Debt Snowball Method. The snowball method is where you pay off your debts by the amount, starting with the smallest and finishing with the largest debt. You do not take interest rates or APR into account unless you have 2 debts with the same balance. In which case you pay the higher interest rate one first.
Once you have your list of debts, you look at your budget and pay minimums on all your debts except the smallest one. Attack the first balance on your list by paying as much as you can towards it every month while still making minimum payments on your other debts. When you’ve paid that first debt off, use the money that you were paying on your first debt, put it towards your next debt and start attacking that one.
You continue that pattern until you have paid off all of your debt and are Debt Free! That is BS2 finished!
What if you have no money left after going through your budget?
But after writing your budget, what happens if you don’t have any money left over to put towards debt? Well, the issue is either that your income is too low, or your expenditure is too high. Or it may be both! You need to go through your budget and adjust and cut anything you can from it. If you have already done that, you need to make more changes.
In this case, you either need to try working more hours (if you work outside the home already) or if you are a stay-at-home parent, then you’ll need to find work outside the home that fits around your partner’s working pattern.
If you need childcare and are worried about the cost, please look at https://www.entitledto.co.uk/ to work out how much better off you will be at work.
Baby Step 3
In my opinion, this is the most difficult Baby Step. I feel like when we are in baby step 0, we have just started and are really motivated. In Baby Step 2 we are on a mission to pay off our debt and will see an end result (more money for us instead of going to creditors). But Baby step 3 kind of leaves me feeling a little flat. Having cash in the bank for no reason other than ‘just in case’ isn’t something I’m familiar with.
Plus, I would also say that this is the first of the Baby Steps to differ slightly from the American system.
What is Baby Step 3?
Baby Step 3 is a continuation of Baby Step 1 where you add to your emergency fund so that it can cover 3-6 months’ worth of expenses. That’s why step 1 is called the Emergency Fund, and step 3 is called the Fully Funded Emergency Fund (FFEF), because it’s a continuation of, not as well as.
To calculate how much you’ll need for baby step 3, you look at your budget and see what you would need to live on per month if you had no income at all.
This is where things differ in the UK, as most of us would be fortunate enough to receive some Government Assistance in the form of Benefits. Assistance such as Universal Credits, Tax Credits, Child Benefit, Council Tax Support, etc.
Whether you take that into account when working out what your 3-6 months of expenses will be, or not, that is entirely up to you.
Also, when doing your calculation, remember that this is an EMERGENCY budget, in case of a job loss, or death, or any other emergency. We don’t include Sinking Funds, any eating out, any pocket money, gym memberships, or luxuries. It’s just what we would need each month to keep a roof over our heads and the bills all paid.
Why do we need Baby Step 3?
Although I am finding BS3 incredibly boring, I do see the value in it. In fact, this is probably (in my opinion) the most important Baby Step, as it’s the one that will stop us from getting into debt once we become Debt Free.
It is our buffer from big emergencies like job losses and can be the difference between putting food on our table or not. It isn’t for dipping into at Christmas time, or if our car breaks down, we cover that with Sinking Funds.
Baby Step 3B
Baby Step 3B is the ‘Mini Baby Step’ that comes between Baby Step 3 (The Fully Funded Emergency Fund) and Baby Step 4 (contributing 15% of your income to retirement) and is saving to buy a house. Similar to Baby Step 0, this is also often overlooked in most of the 7 baby step explanations.
The reason that it is after baby step 3, is that you NEED to have your Fully Funded Emergency Fund before you make what will possibly be the biggest purchase of your life. Similarly, the reason it comes before baby step 4 is that saving for a house is a short-term goal, but you will be in Baby Step 4 for a longer time. You can afford to put off contributing to retirement for a few years to save for your house deposit.
Guidelines for BS3B
Dave Ramsey suggests a minimum of a 20% deposit, although here in the UK there are Help to Buy schemes (starting at a 5% deposit), Shared Ownership, and various other government schemes that can help you get onto the property ladder.
The problem with these 5% deposit schemes, is that a lower deposit means higher mortgage payments. It can be better to save for longer and have a higher deposit to put down so that your long-term mortgage payments are lower.
Another suggestion by Dave Ramsey is that you apply for a 15-year fixed mortgage. While this makes sense, it’s not always easy (or possible!) for the average Joe. I highly suggest using a mortgage calculator and looking at current Mortgage Offers on Money Saving Expert.
The final piece of guidance from Dave regarding Baby Step 3b, is that your mortgage payments should be no more than 25% of your combined household take-home pay. This makes absolute sense, as you don’t want to struggle to pay your mortgage every month.
I hope this helps you understand the first 4 ½ baby steps! We will either update or create a new post that explains the final steps!
James Banerjee is an Account Director who graduated from the University of Kent in 2014. He works in SEO on clients such as HSBC UK and Nestle and he has a keen interest in personal finances and money-saving advice.