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How to truly eliminate your debts.

I used to sell this, but found that people were more interested in buying information about how to get rich via leverage so I'm going to contribute it to the Daily Paul community in hopes that it helps others who are in debt.

How to truly eliminate your debts.
Debtstorm, LLC

Financial matters confuse some and excite others. Many people find themselves feeling trapped by their financial situations. My goal is to show you specific methods to release the financial pressure and to bring back the excitement about your future.

In past years, I have given financial advice and trained clients on how to do budgets, buy insurances, reduce debts, save, and invest for the future. Companies that I have worked for instructed their associates to use a very specific formula for calculating when to keep debt, when to pay off the debt, and how to pay off debt.

The formula is very simple and still true today, however they lied about one extremely important variable. They said: “Pay off your debt if the cost of the interest is higher than the return you're receiving on your investments. Keep your debt if your investment return is higher than the rate you'll pay on the debt.” For example, keep the 7% mortgage because you'll get an average return of 10% from stock mutual funds. You'll end up netting 3%(10% - 7% = 3%). We had computer simulations that showed how much more money you would end up with in 30 years from keeping the mortgage and investing the difference. It was thousands and thousands of extra dollars. Sounds good, right???

WRONG!!!! They lied. The formula is true, however, the variables are flawed. We were putting incorrect numbers into the formula. The true interest rate on that 7% mortgage is actually closer to 60% over the 30 year life of the loan. Look at your mortgage payments. Stop right here and look at your mortgage payment you made this month. You’ll find that a considerable amount goes towards interest and very little( if you’re in the first 20 years of the loan) goes towards the principal. Find the amount going towards interest and divide that number by the total payment minus the escrow and taxes. For example, a $1,000 dollar total payment pays $800 towards interest, $50 towards principal, and $150 to escrow. Simply divide $800 by $850. That equals a 94% interest rate. Mortgages are front loaded and compounded with the most interest paid in the beginning. You’ll probably find that you’re paying 80% or more in interest each month.

So, plug the true interest rate on your mortgage into the formula for deciding whether or not to pay off debt. What happens to the numbers? The above example turns into (10%-94%= negative 84%) assuming a 10% return on your investment. The only investment you’ll find that pays you a higher return than the interest rate on a mortgage is a 100% matching 401k plan from your employer because you will automatically get a 100% return on you investment from the employer match. The above example would be 100%-94%= 6%. You’ll maximize your money by contributing into the 401k up to the point your employer matches 100%. Some companies don’t match the 100%. Some will match up to 50%. This still may make sense because of the tax considerations of pre-tax money and the tax deferred growth, however, those are numbers that you’ll need to determine based on your situation. Most people will be better off paying off their debt if the employer matches less than 100%.

The company also taught us another reason not to pay off a mortgage. A mortgage is tax deductible. They said “It’s smart to keep the mortgage because it is a write off on your taxes.” You have probably heard that same statement several times. It sounds good, right???

WRONG!!!!! A mortgage is only tax subsidized. It is not a 100% tax deduction. Every dollar paid in interest will equal an after tax savings equal to the income tax rate for your tax bracket. For example, say that you are in the 15% tax bracket. You will get back 15 cents for every dollar paid in mortgage interest. Let’s play a game: Send me a dollar and I’ll send you 15 cents. Send me another dollar and I’ll send you another 15 cents. It doesn’t make sense to enter into that kind of financial arrangement only to get the 15 cents. Pay the 15 cents in taxes and keep the difference. Ponder this one for a while. Really think about what you’re paying in dollars and receiving in pennies. It’s a loosing proposition that most of us have fallen into paying. Here’s a tidbit of trivia: The literal French translation of the word “mortgage” is “death bet”, “death payment”, or “death wager”. That’s a scary sounding translation and it has truth in the definition.

If you still have any doubts, let’s talk about the total cost of a mortgage. The average total cost of a 30 year mortgage is about 3 times the purchase price. For example, a $150,000 house will cost about $450,000 with all of the interest added. However, there are tax implications. You’ll get some of the money back in tax deductions if you itemize your taxes. So the first after tax price tag is more like $390,000. There’s a catch. Don’t forget that the $390,000 is after payroll taxes have been deducted. How much income needs to be earned to have $390,000 after payroll taxes? The number is closer to $550,000 for a $150,000 house. Give me a break.

There are big benefits to paying off all of your debt as soon as possible. The following section is an example of how the system works. Your income may be higher or lower than the example, however, debt ratios are generally the same across different income brackets when done in percentage terms. For example, a family that earns $100,000 per year may have $300,000 in debts and a family that earns $50,000 per year may have $150,000 in debts. Both groups have the same percentage of debt relative to their income. Just follow through the following example and put your numbers into the section at the end. You'll more than likely find that the time frames will be similar to the example. Here’s the formula to debt freedom:

Line up all of your debts like the example that follows. Put your smallest debts on the left and the bigger debts to the right. Lay them out from smallest to largest. Write in the total amount and the minimum monthly payment.

This is an example family with a salary of $80,000 per year before taxes and several average debts. Their net after taxes is around $60,000 per year. Thus their net after taxes per month is around $5,000 per month. We’re going to take 10% of the monthly net take home pay ($500) and use that money to work magic. Don't worry about how you're going to find the 10% out of your budget. Just follow the example and the rest will follow.

Visa $2,000 with a minimum payment of $30. MasterCard of $3,000. Min = $40. Car debt of $10k. $350 payment. Truck debt of $20k. $500 payment. Mortgage debt of $150k. $1,200 payment.

Take the 10%($500 for our example) and use it to pay off the debts. Apply the extra money to the left most debt until it is paid off completely. Thus

$500 + $30= $530.

The first debt is paid off in a little less than 4 months ($2000 visa bill/$530 = 3.7 months). Now take all of the money that was going to the Visa and move it over one row. The $530 is now added to pay off the second debt. Thus

Visa = $0 $530 + $40 = $570

The second debt is paid off in less than 6 months ($3000 MC bill/$570 = 5.2 months). Then take the $570 and use it to pay off the third debt. Thus

Visa = $0 MC = $0 $570 + $350 = $920

The third debt is paid off in about 11 months ($10k/$920 = 10.8 months) Then take the $920 and use it to pay off the forth debt. Thus

Visa = $0 MC = $0 Car = $0 $920 + $500 = $1,420

The forth debt is paid off in about 14 months ($20k/$1420 =14.1 months). Then take the $1,420 and finish off the mortgage. Thus

Visa = $0 MC = $0 Car = $0 Truck = $0 $1,420 + $1,200 = $2,620

The Mortgage will be paid off in about 6 years with the interest, taxes, and insurance costs added into the price. The calculations are ($150k/$2620 = 4years 9 months), however the taxes, interest, and insurances add another year or so to the payoff date. The total amount of time to pay off all of the debt is about 9 years. This example is just using 10% of the net take home pay. Imagine what can be done with 15%, 20%, or even a part time job to pay off debt. You're probably still thinking that you don't have an extra 10% to pay off your debts. Don't worry about that yet. The next section will discuss finding the extra money. **** Always give explicit instructions that extra payments go towards the principal. Some finance companies will only apply the extra payments to the interest payments instead of the principal. This is extremely important. Keep records of the extra payments and periodically check with the finance company for compliance of where the extra payments are going. ****

Do your Calculations below: Line up all of your debts with the smallest on the left and the biggest on the right. Calculate 10% of you monthly take home pay and start paying down the debt in order from the left across to the right.

How much time will it take you to pay off all of your debt?

So your next question is how to find the 10% of net take home pay? This is easier than it sounds. Most of us waste massive amounts of money. Look at where your money has gone in the past. Does your past spending match up with your goals? Money gets spent on expensive clothes, entertainment, new cars, big houses, and maybe a little bit goes into savings. This is very important. It is the foundation for your future. Think about your life without a car and mortgage payment. It’s much more relaxing. Think about how easy life will be without the financial pressure. Capture that image, burn it into your dreams, and feel the freedom. Compare those feelings with being shackled in debt. Focus on your goals of debt freedom and align your spending patterns accordingly. You probably found your payoff time frame to be less than a decade. Think back ten years. It’s not that long and the next ten years will be here soon enough. All you need is 10%. The formula will even work if all you can find is 5%. The extra payoff money will gradually build as more of the debts are paid off.

Here’s how to find that extra money. Instead of making a budget, keep a notepad of every single penny you spend for the next several weeks. Stop right here and get a pad of paper to keep track of your spending. You will find several items that can be reduced or stopped. It will become self evident what is wasteful spending and what is worthwhile spending. You’ll most likely find the 10% or more, but don’t worry if you fall short. Just start paying off the first debt and the others will tumble soon after. Spend wisely and reduce debt rapidly. The goal is to spend money on what you really need. You can go to the movies, but maybe there’s a coupon or a matinee. You can buy a car, but maybe a used car instead of a new one. You can go out to eat, but maybe one less time per week. You can go on vacation, but maybe go camping instead of Mexico. Consider selling your expensive cars for less expensive models or maybe even a moving into a smaller house in a less expensive area. These last two considerations are not to be taken lightly, however Benjamin Franklin once said that “the quickest way to wealth is to augment your income and decrease your expenses.”. Selling your house or cars to get out of debt can be a short cut, however it is not to be done on a whim. Your situation, your debts, and your incomes will dictate how to proceed. You will find places to save the extra payoff money whether it be 5%, 10%, or more. The goal is to stop wasting your money on purchases that move you further away from debt freedom.

The underlying assumptions for the system are 1)that you earn more than you spend and 2)that you are not increasing your debt load with new financed purchases. This is not to say that you can't make purchases, but that they are measured against your financial goals and calculated in the pay off system. You won't ruin the system if you need to stop the extra payments for a month or two because of a financial emergency. Just keep after your goals of debt freedom. You'll need to make some of your own decisions if your expenses are more than your income. Make your expense total no more than 90% of your after tax income or increase your income to cover 110% of your expenses.

In addition to debt elimination, there are a few financial cornerstones that go with any plan. First, limit your exposure to losses via insurances. We need car insurance. The liability of causing or being involved in an auto accident can wipe out our entire savings. We need some type of health insurance. You’ll be glad you have the insurance when a hospital bill comes to your mailbox. We need life insurance equal to our debt if we don’t want to pass that debt onto our families. You made need other types of insurances based on your exposures. However, there are proper ways to limit what gets paid to insurances. Talk to several different agents for quotes and advice on proper insurance levels. Look for higher deductibles on your car coverage. Maybe change your sniffle health coverage to a major medical policy if you never use the coverage. Look for term life policies instead of whole life policies. Only get life insurance equal to your debt plus future income replacement value. Term life is cheaper and more efficient. Be smart and always make sure you get new coverage before stopping any existing insurance policy. There are many laws and loopholes. Talk to professionals for advice. The goal is to limit your exposure to losses and reduce the total cost of your insurances while maintaining proper coverage.

Investing is the other cornerstone. This is the exciting part and also an area where this manual disagrees with contemporary investment strategies. You’ll be able to save at a rapid pace after the debt load is gone. Think about the example family. They had $2,620 each month available to invest. It took them 9 years to payoff their debt. Then, they started saving $2,620 per month for 21 years. That’s a grand total of $660,240 cash before any investment gains. Most of that money would have been paid into interest costs if they had paid the mortgage in a conventional fashion.

Here are the three basics of contemporary investing. *First, have a cash emergency fund equal to 6 months worth of bills in some form of liquid assets. ** Second, determine your financial goals and the time frame you have to achieve your goals. Find out what you want and figure out what it will cost. Do you want to send kids to college? Do you want a bigger house or a smaller house? Do you want to retire in Costa Rica or Green Bay? ***Third, pick investments that match your goals. Equities (stocks) have historically outperformed debt (bonds). CD’s are steady return and FDIC insured up to $100k. Money Market funds are steady return and slightly higher than CD’s, but they are not FDIC insured. Long range investments can also be shielded from taxes with IRA’s and the many other forms of tax deferred packages. They are not investments in themselves, but places to put investments so that taxes do not take as big a chunk of your profits. Time lines are also important to consider when choosing investments. Equity markets are typically a longer investment (10 plus years). Bonds are generally fluctuate less in the short run (4 to 10 years). Cash and liquid assets are used for the immediate future (0 to 4 years). Younger investors generally choose equities because of the stronger historical performance and the longer investment time frame. Mutual funds are a popular vehicle for investors because a professional is making the daily decisions and they are spread out among several stocks. Rental property is a very popular investment with tax benefits. Owning a business or being self-employed can also be a great ways to create wealth.

That's the same advice that you'll get from just about every financial planner in the world. Here's my advice. Our financial world is not as stable as it currently appears. Here's the big picture and it is bleak. We have built a financial world based on leverage and illusion. Even the chairman of the Federal Reserve, Alan Greenspan, stated in congressional testimony that he can not define, measure, or control the very instruments of our economy which he is supposed to be managing. He can not define, measure, or manage the money supply with exactness.

1)The United States, the world largest economy, is very close to not being able to pay off it's public and private debts. Our total debt is around 25 trillion dollars in Q1 2005 and growing about 10 percent per year. The total amount of our GDP is around 12 trillion dollars and growing around 4 percent per year in good times. We owe twice as much as we earn and are getting more in debt every day. Every US citizen, man, woman, and child, owes nearly 100,000 dollars in debt. Next year it will be 110,000 dollars for every citizen. However, half of our population does not work. Thus, our workers must each come up with 200,000 dollars and next year it will be 220,000 dollars if the debt is not paid in full this year. The year after it will be 242,000 dollars for each worker.
2)The US Dollar is losing its status as the worlds only major currency. The US Dollar is now among a choice of currencies to own by foreign central banks. There have been several statements around the world that central banks will be selling dollars for other currencies. The net effect of this will be to put upward pressure on interest rates. That means debt, variable rate loans, and mortgages are soon going to get more expensive.
3)The US financial system is a highly leveraged fractional reserve network. Banks do not have enough deposits to cover their loans. That's why they purchase FDIC insurance. Banks will lend up to 90 percent of their deposits out in loans. Leverage is great when you can service the debt loads and none of you bets get called. However, in bad times banks have failed due to insolvency and they will fail in the future just like the S&Ls.
4)The US Current Account (trade deficit) has increased so fast that it is almost parabolic in shape. We purchased 600 billion dollars more from the world than we sold in 2004. Our total GDP production is 12 trillion. That means that we imported(exchanged our wealth to other nations) nearly 20 percent of our total production.
5)The US stock market is overvalued compared to the past century of valuation data. The “fair” value of the US stock market over the past 100 years has been a P/E ratio of 14. The current average, depending on your source, ranges from a P/E of 20 to 30. Bear markets of the 20th century brought P/E ratios to a value of 7 or below before bull markets were born. We are no where close to the start of another Bull Market.
6)The inflation rate is growing faster than what the Bureau of Labor Statics states in the official CPI numbers. The BLS is using “hedonic accounting” to adjust the inflation index lower. Milton Friedman, one of our greatest economists stated that “inflation is always and everywhere a monetary phenomenon”. That means that inflation occurs when money is created faster than goods can be created. Measurable money creation has been averaging around 10 percent per year. Our GDP grows around 4 percent during good times. That suggests that the true inflation rate is 6 percent or higher.
7)Consumerism is what is keeping the United States economy above water. Most purchases in the United States are for short term consumer needs. It's not stable to have an economy dependent on wasteful spending. The rational for borrowing money is to invest it into a returnable asset. Machinery, trade school, and infrastructure could qualify as investments. Expensive cars, new cloths, and fast food is a waste. All lent money must someday be repaid. There will be an accounting of who lent wisely and who squandered their funds.
8)Real estate is a bubble market that is unsustainable. Price increases in real estate have outpaced the fundamental valuations of rents and incomes. The real estate market is now based on speculation similar to the stock market. It is now a fools game of valuation based on a speculator willing to risk that the prices will continue to rise due to someone elses speculation.

So that's the world that we find ourselves living in today. An unsustainable consumer based economy borrowing money from the rest of the world to purchase depreciating consumer knick knacks from the rest of the world. Reality of your surroundings is required to successfully navigate any plan of action. The good news is that we have choices and the world is considerably more wealthy today than at any time in modern history. True, our world economies are on the verge of depression, however there is so much more that mankind has created and invented compared to just a few hundred years ago. So don't despair all hope is not lost, just be aware of reality before making decisions.

Here's my investment advice:

*First, don't invest a dime into any investment until you have completely paid off all of your debts. Most people get excited about investments only to loose their capital in half baked deployments that are almost sure to loose value based on historical parameters.

*Second, have a cash emergency fund equal to 6 months worth of bills in cash and liquid assets ready at a moments notice.**Side note** You might be asking why not have the 6 months of cash before paying off your debt? It takes the average person years to save the 6 months because of their small disposable income and large bills. It’s always smart to have some cash on hand, however, run the numbers in your life. You’ll find that you could probably be close to debt freedom in about the same amount of time that it would take to save up 6 months worth of bills.

*Third, study the works of Benjamin Graham. His two most famous books are The Intelligent Investor and Security Analysis. He is the man who taught Warren Buffett how to invest. Graham consistently earned returns of over 15 percent from his investments by purchasing stocks of solid companies who paid consistent dividends appropriate for the price of their stocks. Think of his stock picks like rental income from stocks. He only choose stocks that had a high probability of paying yearly dividends that would pay for the initial purchase price of the stock within 10 years. Higher stock prices that could be sold to reap capital gains was just an after thought to Benjamin Graham. He focused on real earnings, real sales, real profits, and real payouts to investors.

*Forth, purchase motivational materials and study the classic works of success from philosophers like Napoleon Hill and Earl Nightingale.

*Fifth, Purchase tangible investments that are hedges against inflation while we are experiencing inflationary times. Items like gold and silver have traditionally been stores of value against inflation. **Note to reader. Keeping gold and silver in your house can be a magnet that attracts the criminal element. Don't forget that the government confiscated all of the gold in our country once before and made it illegal to own bullion. If something happens once, it will probably happen again. Figure out a way to keep your tangible investments and home protected and safeguarded ** Real estate used to be in this category of tangible investments, however, it is in a bubble scenario ready to devalue. Foreign currencies that do not inflate as fast as the US dollar devalues are in this category. Gold can be purchased via a stock symbol just like any ETF via a brokerage account. The symbol is GLD.
*Sixth, Invest in the stock market after it has corrected back down to a general P/E ratio around 7 or below. That should happen around the years 2015 to 2020 based on the past century of the US stock indexes. Or use Graham's strict criteria for picking stocks, but be careful, he currently wouldn't buy a single stock on the US indexes if he were alive today. The stock market has fundamental valuations that support justified investments. Do not purchase stocks based on the greater fool theory of there is always a higher bidder.
*Seventh, Be very scared of the US real estate market until it comes back to the real world. The fundamental valuations for real estate are based on incomes and rents. Prices are no longer supported by the pillars of sound foundation. Hoping for capital appreciation is a dangerous game when making an investment.
*Eighth, Own a business that either leverages the time and skills of employees and/or sell a product that duplicates your labor. We have a limited number of “hours” to trade for income during our working careers. Most workers are not fortunate enough to be in a career that pays huge amounts of incomes, like a CEO or a surgeon. Create value in the world and trade that for income.

Watch out for financial scams and people that try to hard sell an investment. Use Napoleon Hill's criteria for distinguishing fact from fiction whenever someone tries to sell you a bill of goods or convince you or an idea. Ask them one simple question. “How do you know what you are saying is true?” You have got plenty of time to make the proper investment decisions. Just keep up with the formula and your net worth will build month after month.

The bottom line is pay off all debt as soon as possible. Your life will be easier and your future will be brighter. Imagine the freedom and resources you’ll be able to amass without the burden of debt. Life is for loving, living, and laughing. I hope that this has given you a definite financial plan and some excitement about your financial future.

Copyright 2003
Pierre Delor

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thank you--

even with fluctuating income, maybe we CAN pay off our mortgage--

that's the only debt we have.

it's hard to be awake; it's easier to dream--

Run the numbers. Most people

Run the numbers. Most people can be free in about 5 years. Some can do it quicker if they start to liquidate the debts and move into smaller houses and get less expensive cars.