Turning debt into… non-debt

I keep hearing these commercials on WBEN for John Cummuta’s Transforming Debt Into Wealth System, and as someone who takes a great deal of interest in personal finance, I wanted to learn more. I tend to be a skeptic, so I set out googling “John Cummuta scam.” To my surprise, it doesn’t actually seem to be much of a scam at all. He’s just selling a methodology for paying off your debt as soon as possible, so you’re not crippling yourself with interest charges. This information itself shouldn’t be groundbreaking to most people, so he’s invented a fancy debt ranking system and corresponding software to help you to determine what order to pay off your debt. From what I’ve read online, it tends to be somewhat counterintuitive to the standard “pay off high interest rates first” instead focusing on paying off the smallest loan balances first, so you can combine the now discontinued monthly payment to the next loan in the list. It’s an interesting idea, but I’d have to model it myself before I believe that it actually works out to your advantage in the long run.

Not surprisingly, in my research I uncovered many bloggers that focus on trying to achieve a debt-free lifestyle, such as Becoming & Staying Debt Free. Different bloggers tend to have differing willpowers towards achieving those goals, ranging from just swearing off credit cards, to living on tunafish and ramen noodles so every dollar possible can be applied towards debt.

Amanda will certainly attest to the fact that I’m a saver more than a spender, but I’m not object to making big purchases when it’s well thought out and planned ahead of time. As with many young, middle-class families, we have a considerable amount of debt in the form of a mortgage, school loans, and car loans. But, what I also uncovered in my surfing through debt blogs is that most of the people who are focusing on debt reduction have a considerable negative net worth, which we do not. This, to me, makes a good starting point for determining how heavily you need to focus on debt reduction.

Determining Net Worth

For all my ultra-liberal friends out there, let me preface this by stating this is only your financial net worth, not your value as a human being. 😉 Anyways, this process is relatively simple. Add up the value of all your assets – savings accounts, investments, bonds, 401k plans, IRAs, and the value of your home. The last one may be tricky since a home’s value can change over time, but you want to use the amount that you could realistically sell your house for. Now that you have your total assets, you need to determine your total debt. That includes the outstanding balance of your mortgage, school loans, car loans, personal loans, and of course credit card balances. You may have additional items in each of these categories that I didn’t list, so be sure those get included as well. Now for the big number – subtract your total debt from your total assets and you have your net worth.

If your net worth is positive by a significant amount, let’s say at least the amount of your yearly gross income, you’re probably in good shape. Statistically speaking, the median net worth of the American family in 2004 was $93,100. That number, of course, doesn’t apply well to individual financial situations, so I like to use the yearly gross income as a better guideline. If your net worth is between that and $0, you’re not too bad off, but as long as you have an emergency fund established, put any extra income towards paying off debt that can be relatively easily eliminated, such as credit cards, before dumping the money into a savings account. If your net worth is in the negative range, you’re going to have to really focus on eliminating your debt, because it’s going to eat away at any amount of savings you may have stashed away.

Derek’s Turning Debt Into Non-Debt Plan®

Disclaimer: I’m not a financial planner, nor do I have a degree in finance, results are not guaranteed, check with your doctor before starting. These tips are a combination of my own research, thoughts, and personal experiences, which you may or may not be comfortable with applying to your own situation. That’s fine, I take no offense. Personal finances are exactly that – personal. Each person has differing feelings towards how much debt they’re comfortable with carrying, so one size certainly won’t fit all. That being said, these guidelines generally apply to everyone, regardless of their net worth situation. They’ve certainly helped me successfully manage my finances, and I hope they can help you.

  1. Pay off high-interest credit card debt. Credit cards are not inherently evil, even though many debt-free advocates profess getting rid of them all. What is evil are the interest rates they carry. People are attracted to low introductory rates, initial purchase discounts, or other perks for opening new cards, and all of those can certainly be used to your advantage IF you don’t carry a balance on the card. Don’t believe what you hear about keeping the credit card companies happy with carrying just a little balance from month to month, it’s unnecessary. I’ve been using credit cards as my primary method of payment for just about everything for over 10 years, always pay in full every month, and I’ve never had a company drop me. The golden rule of credit card usage is never use it to buy something that you can’t pay cash for. If you’re carrying debt on credit cards, and the APR isn’t 0.0%, this needs to be the debt you focus on eliminating first.
  2. Fund your retirement account. I know this doesn’t seem like it has much to do with eliminating debt, but it’s a matter of priority. You need money for retirement, and that money needs time to compound, so the earlier you start saving, the better. If your employer offers a 401k plan, you need to fund it to the point that gets you the maximum employer-matched funds. Otherwise, not only are you not saving, you’re throwing away free money. If your employer doesn’t offer a 401k plan, you can invest in an IRA instead.
  3. Build your emergency fund. Sometimes the best offense is a good defense. It’s hard to feel like you’re making any progress eliminating debt if every time something out of the ordinary comes up, you’re adding to your debt balance. Most financial planners will tell you that you want 3-6 months worth of expenses in your emergency fund, which not only helps with that unexpected car repair, but also gives you a solid cushion should you lose your job. I lean a bit more conservatively with this item, choosing to have 6 months in monthly income saved, rather than expenses. For people in that negative net worth column, your focus is going to need to be on debt elimination rather than building savings. The 3-6 month guideline is probably out of reach for you, but you should still build a small cushion so that you’re not continually adding to your debt baseline.
  4. Eliminate “unnecessary” loans. I put three types of loans into this category: personal loans, school loans, and home equity loans/lines of credit. These loans were probably seemed necessary when you took them out, but they’re the type of debt that once eliminated won’t keep coming back. They’re also the type of loans that aren’t backed by something tangible, like your mortgage or your car. Home equity is a bit tricky, because it is backed by your home, but unless you’re using it to fund actual home improvements that will “guarantee” a return if you sell your house today, you’re essentially “betting the house” with your purchases and could end up owing more than your house is worth between the home equity loan and your mortgage. That being said, home equity is a better way to fund emergency purchases than with credit cards, because the fact it’s secured by your house means you’ll get a much better long term interest rate. You can also transfer high interest credit card debt to a lower interest home equity line of credit so save you some money in the long run, provided you focus on paying it off. Personal loans and school loans are backed by intangible assets, faith and presumed knowledge, and once you’ve taken care of the high interest debt, eliminating these loans will free up your cash flow and reduce that compounding interest that keeps you in debt longer.
  5. Pay off car loans. If you’re eliminated all your other debt and gotten to this point, you’re in pretty good shape. If you have car loans and you’ve fully funded your emergency account, why not get rid of these loans too? This is where it begins to make sense to look at interest rates. If you’re getting 5% in a savings account and paying 4.9% on a new car loan, you’re losing money, not gaining. Inflation will eat away that margin difference. You’ll be better off shifting your savings towards paying off the loan early, then putting the extra income into your savings account. This is also important if you purchased a new car with a low down payment, as you can end up “upside down” on your car loan, meaning the car is worth less than you owe on it. Hop over to Kelley Blue Book and punch in your car to see the current value. If it’s less than what you owe on it, make this a priority.
  6. Make extra mortgage payments. If you’re fortunate enough to have eliminated all your other debt and all that’s left is your mortgage, there’s no reason you need to keep making that same payment for 30 years. Can you afford to make an extra payment each year? You’ll cut at least 5 years off your mortgage. Since the IRS still lets you deduct mortgage interest, you’ll get a tax advantage too. If you’re a really, really focused person, have considerable free income, and are willing to eat a lot of rice and beans, it is possible to pay off that mortgage in 5-7 years like Cummuta says. It’s probably not the lifestyle that most of us want to live, though.

That’s the plan that I follow. Amanda and I are currently in step 4, and just this week we paid off a home equity line of credit that we used to reside our house two years ago. Taking a conservative approach, I built up our emergency fund to six months of income. Once it crossed that amount, I shifted a chunk of our savings to completely pay off the HELOC. That knocks us back into the 5-6 months of income savings range, which is still fine, and well within my personal tolerances. Many of the debt-free people would say that I should more aggressively focus on paying off our remaining school debt now, but we’re planning on taking a bigger vacation next year, and I want that to be savings-financed, not debt-financed. This planning is made a lot easier by my budget spreadsheet, where I can easily see how shifting funds around will affect my emergency savings.

It is possible to be debt-free. It’s also possible to get there without making your life a living hell. The first step is understanding your situation and coming up with a plan to get there. I hope this helped.

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  1. It is my understanding that a homeowner should never pay off their mortgage. As you mentioned, the interest is deductible. Assume a homeowner A has a 15-yr mortgage opposed to a 30-yr mortgage for homeowner B. Homeowner A will have his mortgage paid off sooner with larger payments along the way. Person B will have a lower payment and, here’s the rub, be better off presuming he invests the difference. Home interest rates are something like 5.5-6% now I think. That’s a great rate compared to the 8-10% that can be gained in the investment market over the long-run (and 30 years is a long run) all the while deducting that interest paid for 30 years. When interest rates are low it is suggested that the homeowner take a home-equity loan to make repairs, go on vacation, give money to the kids. I do not see the sense in having money wrapped up in the home that can be used elsewhere at a great rate…IMHO.

  2. Debt financing investments is always a risky bet. Using a 6% mortgage or HELOC to make 8% in the stock market nets you a 2% gain – not much of an advantage. And that’s assuming you actually make that much and don’t lose money.

  3. Derek, Thanks for your article. You have a lot of interesting points about eliminating debt.

    I would agree with you on paying off your mortgage early. True wealth is only your income relative to your lifestyle. Some people who make a lot of money are poor because their spending exceeds their income.

    By paying off your 30 year mortgage early you free much tied up cash to invest in your retirement, or if hard times hit, owning your home allows you to survive the tidal wave with little means.

    You can’t put a price on the piece of mind that owning your lifestyle brings.

    I am going to download your budget spreadsheet and see if some of your ideas might be useful in the free software I offer on my website. We offer a system similar to John Cummuta, except it is 100% free. I am a web developer and have developed it in my spare time and would appreciate any of your feedback.

    Thanks again


  4. Sounds similar to Dave Ramsey’s plan … just in a different (and slightly worse, IMO) order. I think step 2 and step 5 should be switched. Cars cost a lot and the monthly payments are usually much higher than credit cards, even though the interest rate is lower. Plus, they’re a depreciating asset. Owing lots of money on something that is quickly losing value is a dumb idea. Plus, if you could get rid of that car payment quickly, you could spend a lot more money every month on the later steps (retirement, emergency fund, pay down mortgage).

    I agree with Derek that James’ idea is not very good to say the least. Borrowing money on your house to invest in the stock market (which is what he’s effectively advocating) is extremely risky. Plus, it fail to account for taxes on the expected 4% gain and the risk associated with stocks (paying down a mortgage has ZERO risk). Factor that in to the equation and there doesn’t seem to be a significant financial advantage to that method. I’d take a $200,000 paid-for house any day over a $200,000 mortgage payment with and $200k in the stock market. Most people would too.

    Also, that “tax deduction” stuff is the dumbest argument I’ve ever heard and I seem to hear it fairly frequently. Basically, you’re paying interest to the bank so that you can deduct the interest off your income and not pay taxes on it. Thus you’re deliberately paying $10,000 in interest to the bank so that you don’t have to pay $2,500 (taxes on $10,000) to the government. That’s just stupid. Anybody would tell you that it’s better to pay the $2,500 in taxes and keep the remaining $7,500 than it is to give the whole $10,000 to the bank. Duh.

    Good article though. Thanks for the info on his system. It sounds so “scammy” on the radio ads. He’d probably be more successful if it wasn’t pitched like a “make money fast by not doing anything” shtick.

  5. Good stuff. i agree with just about everything you advocate. i wish you could talk to my brother-in-law. His thinking is more in line with the “Never pay off your mortgage and borrow the hell out of your home equity so that you can invest in the stock market, multi-level marketing scams (er… schemes) and support a rich and famous lifestyle via debt financing” school of thought.

    i found your site because i was also curious about the John Commuta ads i’ve been hearing on the radio.

    Being an accountant (and therefore conservative), the only thing i would change regarding your computation of net worth is to use the original cost of the house instead of market value when valueing your assets (it’s the “lower of cost or market” approach). This way, too, you match the cost of the house against the outstanding balance on the mortgage (it’s called the matching principle in accounting). Alternatively, if you want to value your home at market, you should value the home loan at the outstanding balance of the mortgage plus the sum of the future interest payments on the remainder of the loan (don’t include the principal part of monthly payment). IMHO, of course.

    Great stuff overall, and a very practical and pragmatic approach.

    – ecp

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