Prioritizing Investments Made by Households
By Clint Kennedy
June 15, 2011

    Household investors are bombarded with options and advised to invest in 401Ks, mutual funds, stocks, bonds, invest in their children’s education, their retirement, etc.  How can these be prioritized in the most sensible way, considering the best return financially and according to family values?  The answer is to pay off the mortgage on your house first.  This is probably surprising.  Not too many financial advisors are going to tell you to do this.  Most financial advisors have some product to sell, which will take first priority.

    Let’s take an example.  Suppose you buy a house with a mortgage of $100k and an interest rate of 4%.  Your monthly payment for principal and interest© is $477.42, annual payment $5,729, and total 30 years payments add to $171,871.  You pay interest of about $72k over 30 years.

    Now let’s say that you have $10k to invest and you pay the mortgage principle down with it, leaving $90k as the remaining principle (100-10=90).  Then assuming the mortgage continues for 30 years, you pay a total of $154,685, or about $55k in interest.  You save (72-55=17) about $17k interest.  That is 170% return on your 10k investment and it’s guaranteed.  This example is a bit simplified, but the point holds true.  There are no investments that offer that high a return and have it guaranteed.  Most high return investments have a corresponding high risk involved.

     The first major benefit for paying down your mortgage is reducing the interest you pay to the bank, which yields a high return on your principal loan payments.  This return will even be higher than the example because banks front-load the interest for mortgage loans.  Front-loaded means the interest is mostly paid first, before you pay down your principal.  The first years of your mortgage payments go almost entirely towards interest.  The last years, years 27 to 30, go almost entirely towards principal.    

    The second major benefit involved with paying down the mortgage is that the banks may move back the due date for the next payment.  Call your bank and make sure.  In our example, the next payment due date would be in about one and a half years.  This is a huge benefit to this investment option because if you lose your job, then you don’t lose our house!  

    Many people won’t pay their mortgage down a lot because it’s like money lost, i.e. you can’t get it back without refinancing or taking a second mortgage.  However, since the next due date is pushed back, this is a minimal risk.

    How many families in the past decade have followed the advice of diversified investments, 401Ks, etc, while paying the regular mortgage payment, only to have the bread winner of the family lose his or her job and then lose the house?  This is a tremendous setback for families that may have been working for many years to have a secure future.

    Increasing equity in your home leads to reduced need for life insurance.  You can pay less for your life insurance because you don’t need as much of it.  The kids will get the house.

    What about vacation investment plans?  Simply the worst investment there is.  Recessions are inevitable.  Losing your job is inevitable.  There is no room for extravagant spending.  First cover the necessities and plan for the worst.  It reduces your stress.  Even if you lose your job, your family still has a place to live.  Lower stress levels in the long run mean better health and longer lives.

    What about buying my dream car?  Cars are an investment of necessity for transportation.  Any cost to the car above the minimal cost of a reliable car for the number of passengers traveling is a cost of pleasure.  Almost all cars depreciate as soon as you leave the parking lot.  The car investment is really a matter of minimizing loss, unless the household has sufficient savings for pleasure items.  A household should have sufficient savings to pay all expenses for at least six months in case the household income earner loses her job.  The next recession is inevitable and US families need to plan for it.  American automobile workers need to produce cars that will last as long as possible with the least energy usage at the cheapest cost possible.  

    When should a new car be purchased?  With the view of minimal expenses, it should be when the monthly payment of a new car is less than the monthly payment of repairing the existing car.  A reliable mechanic can tell a consumer what repairs are likely to be needed in the near future.  Then the consumer can make a proper budget decision.

    I don’t have a house?  Plan to get one as soon as possible.  Rent payments are a total loss with no return.  Owning a house provides several possible returns.  The value of the property can appreciate.  The interest payments are tax deductible.  Units in the house can be rented, or the entire house can be rented.  Mortgage payments partially reduce the principle portion of the loan increasing the homeowner’s equity and overall assets.  The owner can sell the house and take the appreciation and the equity.  Again, homeowner’s should have six months of expenses saved, so buying a house takes some significant savings.

    What is the affect on the US economy of the mortgage payment priority?  The benefit is huge.  Banks have more reliable payers.  Inevitable recessions cause a greatly reduced number of bankruptcies and foreclosures.  When foreclosures occur, banks have more equity in the home and take less of a loss when selling the home.  When consumers have more equity in their homes there will be increased stability in the value of the homes.  Then housing prices will go up!  

Copyrighted © June, 2011 by Clint Kennedy