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How Dave Ramsey's bad math leads to bad advice.

Byline: Michael Markey

Bad math equals bad advice. While much of Dave Ramsey's advice is helpful and accurate, some is hazardous. Yes, hazardous: It can cause harm. It is hazardous to eliminate interest charges to merely increase taxable liabilities. You would think someone who refers to the government as a parasite (true story!) would understand that paying less in interest to only pay more in taxes is NOT a benefit.

I found Talisha from Greenville, S.C. as I scoured YouTube watching Ramsey video after Ramsey video. Talisha called in to ask about whether she should rent or buy a home. She said, "I'm here with my husband, Patrick, and we're having the discussion on whether to rent or to buy. Patrick's main argument is my student loans. I just graduated from pharmacy school last year and have $245k " This is where Dave loudly interrupts with his "Good Lord," to which Talisha responds with a giggle.

Here are the high points: Dave suggests they do absolutely nothing but pay off this debt. He refers to it as "an amazing amount of debt," and tells Talisha she should be in panic mode. He tells her to act like "your freaking life is about to come to an end." He says, "This is a disaster." He advises they find an apartment over a garage and "mow the old lady's grass for free rent." He concludes his rant by telling Talisha and his listeners how her industry has normalized this debt as acceptable, and that she needs to do the opposite.

Is it possible that all of these "stupid" people (a word Dave uses to describe most of his naysayers) aren't so stupid after all? Is it possible they slowly pay off their student loan debts because it's advantageous?

I know the Ramsonites don't agree with me yet. But you will. If you're a Ramsonite, stop here for a moment. Remember how much you disagree with me right now because, by the end, you'll come to see how Dave gave Talisha bad advice, and how bad advice hurts people.

Here are the additional details you need to know: Talisha now makes $110,000 a year, while Patrick makes $50,000. While she's been in school they've been able to live off of his income only. Mr. Ramsey says their income will go up to $200k in a few years, and that they should be able to pay off the student loans in 21/2 years or faster if they really get serious.

But do they really need to be so serious? I understand $245k of student loans is a lot of debt. I understand the payment can be burdensome. I understand the interest charges are meaningful. I also understand different people need different advice. But this is not a crisis. This is not a disaster. Talisha and Patrick if you're reading this, DON'T FOLLOW DAVE'S ADVICE! Get local counsel. Meet with someone who will address your specific situation. I will do my best here, but certainly I still had to make some assumptions.

Three scenarios

I went to to calculate the taxes for each of the three scenarios we'll walk through below. For all examples, I assumed a 5 percent fixed interest rate on the loan, with a 20-year payoff. I also made the same income increase assumptions in each scenario. This wage increase may seem unrealistic to you, but remember, it's Dave's assumption, not mine.

The first scenario is Dave's plan, followed by two alternatives.

To find out how much they currently live off of, I assumed they file as a married couple with no dependents and standard deductions. This makes their current take-home income $40,590. I disagree with Dave that they should live like hermits now (or, as he puts it, live like no one else now so later you can live like no one else). I think it's reasonable to reward yourself a little bit, so I assumed they'd now spend an extra $1,000 per month on various things they've gone without over the many years Talisha's been working to get her degree. Receiving an extra $110,000 of wages and only rewarding yourself with $12,000 is more responsible and disciplined than most would be.

OK, here's how year one of Dave's plan will look. Our couple has $160k of income, but they'll owe $42,752 of tax. They spend $52,590 on living expenses and other debts. I applied all the extra cash flow towards the student loan debt. Although they're aggressively paying down the student loans, they'll still have about $10k of interest paid, which we accounted for while calculating their taxable liability.

In year two, let's assume, as Dave has done, that their income will go up from $160,000 to $180,000. With $180,000 of income our couple had to pay $50,315 in taxes, but the good news is that their interest expense went down to $7,834.

In year three, we give our couple their last raise, bringing their income to $200,000. They owe $58,714 in tax and only paid $4,666 in student loan interest.

Finally, in year four, we maintained the $200k income. The tax went up slightly to $59,826, since the student loan interest deduction continued to decrease. The total interest and tax paid over the four years is $235,535 ($211,607 taxes; $23,928 interest).

Why would we add the two amounts together, you ask? Simple: There's really no difference between interest payments and tax payments. You have to pay both. If I have $100 bucks and I owe $10 of tax or $10 of interest, isn't the net effect the same? Likewise, $2 dollars of tax and $8 of interest is the same to my cash flows as $8 of tax and $2 of interest.

For the second scenario, I ran the numbers in their simplest form. We will not be buying a house, we will not be giving, we will just pay the minimum on the student loans, we will max out the 401(k)s, we will spend the same amount on sundries and normal living, and we'll save every additional penny. Wait Cytil Talisha sees these numbers. Wait until you see these numbers. Skip ahead and take a peak.

The numbers for year one are quite similar to the numbers in the first scenario. We had the same $160,000 of income and approximately the same amount of student loan interest, but instead of allocating every free dollar to the student loans, we only paid the minimum of $19,404. With the extra cash flow, we were able to max out 401(k) contributions for both Talisha and Patrick. With an employer match of 50 percent of the contribution up to 3 percent of salary, this adds up quickly (future wage increases will, of course, also create greater employer matches). Our couple still owes $32,893 of tax, but even after maxing out the 401(k) at $15,000 each, they have $25,112 left to put into savings.

Before we continue, let's talk about why debt can be good. Dave's philosophy is "Play with snakes and you'll get bit." I agree. Having no liquid savings is playing with snakes. By following Dave's advice like a gazelle on steroids, our couple has almost no savings until they finish step two (aside from the massive $1,000 emergency fund Dave recommends to all of his listeners). With Dave's plan, our couple has no protection against loss of job or unexpected emergencies. Even if they did save a bit more, our couple is in the 28 percent federal tax bracket. Therefore, the interest deduction is advantageous for them.

I know Dave says that's stupid. In fact, he argues this very point in TTMM: Why pay $10,000 in interest to save $2,800 in tax? Here's my answer: If our couple doesn't put every dollar towards the student loans, then they can afford to invest in 401(k)s, save for emergencies, buy a house, and give. Three of these are deductible, which further reduces our couple's taxable liability -- which, in turn, further proves Dave's hazardous math isn't limited to rates of withdrawal or rates of return.

Dave also says the number one indicator of wealth is not rate of return, nor fees, but amount saved. If the number one indicator of wealth is saving, not spending down debt, then why shouldn't our couple start saving while they're spending down their debts? Are you with me yet?

Now, back to our second scenario. In year two our couple has $180,000 of income. They continued to max out both 401(k)s and pay the minimum on the student loans. They'll incur $11,742 of interest charges, but only owe $39,374 of tax. Oh, and they'll have $38,631 of income they can save. (In case you're wondering, I assumed a 0 percent APR for the amount stashed in savings. I wanted to eliminate the advantage of additional interest income so there wouldn't be any arguments.)

In year three, our couple owes $46,190 in taxes and still pays $11,349 in student loan interest. Excitingly, they are able to put an additional $51,815 into savings.

In year four, the taxes go up to $46,322 and interest expense is down to $10,937. (I know, too many numbers gets boring, but stay with me.) At the end of this fourth year our couple has saved $167,241 in cash, and has combined 401(k) balances of $160,992 (and this is at a 6 percent CAGR rather than the 12 percent Dave suggests!). Most important, over the four-year span, our couple has paid $25,638 less in taxes and interest than they did on the first plan.

Before you agree with me that this is a better plan, remember our couple has only paid the minimum on their student loans. They still have a balance of $214,124 after four years. Maybe I should stop here and admit defeat. You don't really think I meant that, do you? Onward and upward, here we go.

Don't worry about the student loan balance because in one more year -- 14 months to be exact -- our couple has $207,004 in their 401(k)s, $218,786 in cash, and $205,226 in student loan debt. They CAN pay the loan off in full at the end of year five, if they'd like to. While it is true that paying toward these loans for 14 additional months garnered more interest charges, it is not true that avoiding the interest charges would lead to a net savings. They still pay over $18,000 less in total charges. At the end of the fifth year in Dave's plan, our couple will have about $180,000 less in their 401(k)s, so although they will have almost $80,000 more in savings, their total net worth will be approx. $90,000 less.

Seems pretty simple, doesn't it? Pay less in taxes and interest, and have more money for emergencies during the process and more at the end. But I'm not even close to being done.

In this last example, we didn't follow the advice from my previous column outlining the seven steps Ramsey followers really need. Our couple could buy a house and they could give. Let's see how things turn out when they do both of these things.

Here's our third scenario: In the first year our couple is just starting to make money, so they don't have enough cash to buy a house if they start to give. Let's say our couple gives $16,000. Their tax owed would go down compared to our first two plans. Our income after tax would therefore be greater. However, after giving $16,000, they're only left with $12,561 to put into savings. (Of course $12,561 is better than zero, which is the mathematical reality in Dave's plan.)

In the second year, our couple is still saving up for a house purchase. They're getting closer. They now have $180,000 of income, and donate $18,000. After paying taxes they have $145,066 of income. They'll continue to spend the same amount on living expenses ($52,590), spend the same on their student loans ($19,404), and save the same amount in their 401(k) accounts ($30,000). This leaves them with $25,072 to put into savings.

In the third year, our couple now has enough to buy a house and put 20 percent down. I visited Zillow and typed in Greenville, South Carolina. I found a number of homes in the low 100s. I'm assuming, based on Talisha's comments, that they've never owned a home and could thus possibly take advantage of non-income based first time homebuyer incentives like home path financing. The payment with taxes and insurance would be about $750 ($120,000 home, financing $94,000 at 4 percent for 30 years). Seven hundred and fifty dollars per month is, quite frankly, probably the same amount they were paying in rent, if not less. There will be no additional increase to their spending. Thus, in year three the math is the same as above, except that the additional $20,000 of income increased charitable contributions by $2,000. After deductions for mortgage interest, property taxes and moving expenses, the income left at the end of the year is $22,175.

In the fourth year, there aren't too many changes. Our couple has the same income and basically the same deductions. They don't have the cost of a down payment, and therefore the cash left over at the end of the year is $38,546. At the end of the fourth year, they've paid only $142,666 in taxes, $45,118 in student loan interest, and have $160,922 in 401(k)s, while also making $74,000 in charitable contributions over the total period. Because of these charitable contributions, there's not enough cash to pay off the student loans until the end of the seventh year. At that time, they've given $134,000 to charity, paid about $260,000 in taxes, and paid about $65,000 in student loan interest. Total interest and taxes for plan three at year seven is approximately $326,714 compared to $359,367 in plan two and $385,076 in plan one.

It's helpful to view all these numbers side-by-side.

Here's the four-year breakdown for all three scenarios:

[Table omitted]

*NOTE: The last plan paid less in taxes plus interest and has a higher net worth than Dave's plan, despite giving $74,000 to charity.

*NOTE: The middle plan could use some of the savings balance to make lump sum payments against the student loan balance. This would further improve the total tax and interest savings.

Here's the five-year breakdown for all three scenarios:

[Table omitted]

*NOTE: The last plan paid less in taxes plus interest and has a higher net worth than Dave's plan despite giving $94,000 to charity.

*NOTE: The last plan could use some of the savings balance to make lump sum payments against the student loan balance. This would further improve the total tax and interest savings.

Here's the seven-year breakdown for all three scenarios:

[Table omitted]

*NOTE: The last plan paid less in taxes plus interest and has a slightly lower net worth than Dave's plan despite giving $134,000 to charity.

*NOTE: If we use Dave's famous 12 percent rate of return, then not only has our couple saved on the sum of taxes and interest in the last plan versus Dave's plan, but their net worth is $420,807 compared to $361,091. Therefore, using Dave's rate of return, our couple still shouldn't immediately pay off student loans since they can invest, buy a house, and tithe while still enjoying greater personal wealth. This is why us "math nerds" use calculators!

Which reality is better? Which would you choose? A classic Dave objection, of course, is to spout that I can't guarantee our couple will save the money or keep their employment. But if we assume they'll spend down debt in Dave's plan, we must assume they'll save in the other two plans. Fair is fair, after all. Without financial discipline, none of the scenarios work.

Before seeing the charts, you might have been tempted to argue that the increased savings in scenario one (after the debt is paid in full) would propel it past the other plans. But the numbers show clearly that plan two only has 14 months of additional interest payments, and has a $160,000 head start. Can 14 months of no student loan payments compare to this? Not a chance.

Bad math creates bad advice. Bad advice creates bad plans. Bad plans are hazardous. Paying more in taxes to save on interest charges is ill advised when the aggregate amount paid exceeds the benefit.

I do agree with Dave sometimes. I agree that no one is forcing kids to get loans, and that kids need to get real degrees (not a Ph.D. in German Polka History). I agree that kids need to graduate in four years. I don't agree that ALL debt is bad. Student loans are not a crisis. People will pay their debts. Not paying your debt has real, tangible short-term consequences.

Teaching people to save is difficult. Dave was once the master of this. Today, maybe not so much. If the No. 1 indicator of wealth is how much someone saves, then we must focus on a plan that allows him or her to save the most. Telling someone to only focus on debt is like telling someone who's overweight to only focus on cutting calories a walk here and there might help, too.

Have you heard Dave give bad advice based on bad math? Let us know.

As always thanks for walking down this path with me. If you see something you'd like us to address from American's "Favorite" finance coach, please email my editor at

See the earlier articles in this series: Why Dave Ramsey is wrong about permanent life insurance Two great Dave Ramsey myths, debunked These are the 7 steps Dave Ramsey followers really need
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Publication:National Underwriter Life & Health
Date:Jul 1, 2015
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