Dave @ 8:59 pm August 18th, 2007
This is not a correct statement. Anything is an investment that you put money in to. A house is only an asset if you sell it, and only if you sell it for a profit.

If you get a mortgage to buy a house, and the house drops in value, the mortgage does not go away. You are still obligated to pay back the original value plus interest. If you pay in cash and the house goes down, you’ve lost the same amount of money.

However, if you decline to buy a house and simply rent, then you have eliminated the risk of housing downturns.

What mortgages do from an investment perspective is increase leverage (and thus risk) for speculators. In other words, if you have $10k to invest, and you invest in a house (also taking on a $190k mortgage), you are taking a serious risk. If the house drops 1%, you’ve lost 20% of your investment.

I’ve got a slightly different perspective, I think. I like to think of things in terms of cashflow, as narrow-minded as that may sound.

I don’t mind debt–especially my low fixed mortgage in this environment–but I do prefer to have the flexibility of a large net positive cashflow. At the moment, I don’t have that because of mortgage payments. So, despite the advantage of the low fixed debt, I’m leaning toward more of an early payoff so I can put the whole mortgage payment toward other investments.

I’m pretty sure I’m going to pay down half my mortgage, keep the rest in cash for a new roof, braces for the kids, etc. and keep up my frugal ways which have allowed me to build this up in the first place. At worst case, it will be another 2 years or so before I can retire the mortgage.

I’m still in it for the long haul (IRA and 401K maxed) in fairly aggressive stock portfolios.

The comments on Trent’s original post have been very enlightening. There is no “right” way to invest when taking personal risk tolerance and psychology into account.

I actually agree with a lot of the analysis above. I will say that Trent’s summary of my situation is mostly correct (I do tend to view my house as an investment). A few points:

- I do have a pretty high risk tolerance. I’m quite comfortable with investing a large percentage of my income in stocks, etc rather than real estate, if I think that’s the best move.

- I disagree with some of the commenters above that do not view their house as an investment, but not in the way one might expect from my earlier comment. I don’t view it ONLY as an investment, but as BOTH an investment and a place to live. I’m perfectly willing to “lose” money on having a nice shelter (in the form of interest payments), in much the same way that I would “lose” money if I was renting. But I only want to lose money up to a point…mainly near the point where I could break even by doing something different (such as renting for a lower monthly payment). When making a big purchase like a house, I evaluate all the opportunity costs (like how much could I make if I rented instead, and invested the difference in the stock market) along with my expectations of the likelihood of the home going up in value.

- I don’t expect to stay in the same house forever at this point in my life; my career is changing too fast for me to be able to expect that. So that’s definitely a part of it.

- I’m considering the effect of leverage on my investment returns on the house. Having a relatively smaller amount of equity in your house can actually magnify your investment gains (or losses) if the house goes up or down in value between when you buy it and sell it. I want to have enough equity that I have some safety against downturns in the housing market, but not so much that I tie up the majority of my wealth in the house. Also, because the home equity is less liquid, it’s harder for me to redirect it in the future to some other investment that I think will do better. This could reduce my total investment returns, because I might not be able to put the money to work in the most efficient way possible.

Again, I agree with everyone who says this has a lot to do with psychology and differing risk tolerance. For some reason debt creates an irrational insecurity in many people, and I totally understand why that type of person would want to pay down all their debt to “feel safer”. I, by contrast, feel safer having more money in liquid assets, even if that means I retain debt longer. I can then handle any personal emergencies that life throws at me with no problem. I also like to “globally optimize” my finances, looking at the best places in every area to put my cash.

In the case of a home loan, this should be considered as shelter first, inflation hedging second and lastly as an investment. The first two effects are far more likely outcomes of owning a primary home.

By having a loan, you’re exposing yourself to all the factors associated with credit risk. If you have no cash, you’re exposing yourself to liquidity risk. By investing in something, you’re exposing yourself to financial risk.

So how is it that some of you are arguing that not paying off your loan and using it to invest in stocks is not MORE risky than paying off your entire debt. Anytime you take your cash (hopefully not all of it), all else being equal, and invest it in something inherently risky (stocks), it is more risky than paying off a loan (less default risk). That IS the reality of the situation.

Whether you’re okay with that risk is another question and is up to you.

A lot of you guys are confusing risk with risk tolerance. Yes, some you’d rather have some debt and invest some, but that doesn’t mean you’re not in a more risky position than the guy who paid off his entire debt. Of course, as some of you pointed out, your return will probably be a lot higher than the no-debt guy if everything goes well. However, you risk to lose a lot more if things don’t.

On a side note, diversification only works well with things that are not correlated. As we’re seeing today, mortgages and stocks are tied a lot more than we thought eh?

Another thing, diversification only saves you if you can sell your investment. If your home is your shelter and you can’t/won’t sell it, the whole being diversified thing doesn’t really work now does it? Why? Because the point of diversification is that you can minimize unnecessary risk by offsetting returns (that are negatively correlated (eg stocks and bonds). If you can’t realize the gains or losses on the investment by selling, diversification fails to be a factor.

Exactly right. An now it’s time for this generation to learn the same thing.

Family said we were crazy for not living in a high priced state and buying a half million dollar home. Well first off, would couldn’t afford that. Second, I can’t see working my whole life for one house just because family lives down the road. They aren’t paying my living expenses and I want more out of life.

I put 20% down on two fixer upper, multi units in the Midwest.If you shop carefully you can buy one for $20,000. I lived in one and used cash to fix them. I didn’t have cash saved. I just saved for cabinets then installed them. Then moved on to the next item. Always using cash. I charged low rents. I increased them as the apartments improved. Other than improvements, I put all my husbands income (I don’t work) plus collected rents on the mortgage.

I’m currently living and renting a place in California for a while. We made the decision to come care for my mother in law who is not well. When the time comes to move back to the midwest I will buy more properties and repeat over and over.

The most important thing we did was learn the difference between needs and wants. We wanted to live in California but needed to live where homes were reasonably priced. We shop at goodwill. We spend $25.00 a week on groceries. We don’t eat out or go out. We make our own fun at home. We have day trips instead of vacations and we buy used cars.

At one time we moved across the U.S. for a job that fell through. We ended up homeless for a while. Once you’ve been there you know that having paid for assets and no risk is a much smarter move than holding debt and “investing” in other things. I remember my grandparents talking about life during the Great Depression. When I was homeless I experienced the real desperation they had told me about. I learned that risk is only fun when everything goes right.

You said John is focused on the investment. The rental properties we own are are multi units. Now keep in mind we own them free and clear now. After taxes and repairs it’s all profit. I think that is a pretty good investment. I didn’t need to hang onto the mortgage for fifteen years to make that investment pay.

“There’s actually a personal risk to paying off the mortgage early. In the event of a catastrophic event, such as a medical situation or extended job loss, your liquid funds to handle the situation have been reduced by having paid off your mortgage. Leaving less room to sell your investment if you need to.”

If you have no payments you can save everything you make. In an event you will have all your savings and income to handle it and no worries about becoming homeless. That makes more sense than having debt and some savings.

We own two rental properties. We did have a mortgage but we paid them off in full in five years. It’s amazing what you can do when you live like no one else and prioritize. We did all that on less than $40,000 a year. People made fun of the clothes I wear and the car I drive but I laughed back at them.

You are absolutely right. I would rather have a debt free place to live and food to eat when the crash occurs, than to have investments and live in a shelter.

There’s actually a personal risk to paying off the mortgage early. In the event of a catastrophic event, such as a medical situation or extended job loss, your liquid funds to handle the situation have been reduced by having paid off your mortgage. Leaving less room to sell your investment if you need to. This is not against paying off your mortgage early (I paid mine off early). Just pointing out the personal risk involved.

Exactly, sometimes the maths is just better.