Ramit Sethi: 2 Things To Consider When You Want To Invest but Have a Mortgage

Should you pay off your mortgage before you start investing? The answer could depend on whom you ask. For financial expert Ramit Sethi, there are two key factors to consider before making the decision : math and psychology.

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The Math

When Sethi says to consider the math, he means you should calculate whether paying off your mortgage or investing makes more objective sense financially. In other words, which action will put you in a better financial position?

Sethi says your mortgage interest rate is the key factor that determines this. If yours is 6% or higher, you should try to pay it off faster. However, Sethi says you shouldn’t pay off your mortgage faster if it’s below 6%. This is because the math shows you can earn more than 6% from relatively low-risk investing.

For example, the S&P 500 has returned an average of 10.5% annually since its inception in 1957. If your mortgage interest rate is 3%, there’s no reason to pay it off faster than needed. By investing that money instead, you’d essentially earn 10.5% on money you’re borrowing for 3% — a surplus of 7.5%.

This can add up to hundreds of thousands of dollars over the life of your mortgage. But it works only if your interest rate is low enough.

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The Psychology

Although Sethi has become famous for offering clever financial advice, he recognizes that people act irrationally with their money. For example, most of us consider more factors when making decisions than what’s optimal financially. These can include family circumstances, our goals and the emotional impact of our financial decisions.

That’s why Sethi says you should also consider psychology when deciding whether to invest or pay off your mortgage. If having a mortgage stresses you out to the point where you struggle elsewhere in life, Sethi says it’s OK to focus on paying it off first. Just make sure you recognize the financial sacrifices you may be making by doing so.

For instance, what if you knew you would be $100,000 richer if you invested instead of paying off your mortgage early? Would you still choose to get rid of the debt just to simplify your life?

This is the kind of analysis Sethi says we should all do when deciding how to allocate our finances. According to him, you don’t always have to make the most optimal financial decision as long as you understand why you’re going against it.

Does Psychology or Math Matter More?

Sethi says we should consider psychology and math when deciding between investing and paying off a mortgage. But does he say which point of analysis should be the priority? Not exactly.

Instead, Sethi tells us to simply be aware of the role that psychology and math each play in our decision-making process. Every person has to decide which factor matters more to them, but they can do so effectively only if they have this awareness in the first place.

Other Factors To Consider

There are other factors worth considering, too. Here are four that could impact your decision.

Age

Age becomes important as you get closer to retirement. For example, maybe your income will drop once you quit working. If so, it could be smart to pay off your mortgage in advance. Doing so could make your retirement much less stressful.

Future Goals

You should also consider your future when making this decision. Other investments tend to be more liquid than real estate, which means you can access the capital more easily when you need it. This could be important if you have expensive plans coming up, like traveling or buying a boat.

Risk

The S&P 500 may have an average annual return of 10.5%, but it can go down a lot in any given year. Serious market crashes can also take years to recover from. If you don’t want to risk losing money in the short term, paying off your mortgage early may be the better option.

Changing Circumstances

Finally, it’s also important to recognize that your financial and life situations can, and probably will, change over the years. You could have a child, get married, move across the country or simply change your goals.

These situations can all impact the optimal way to manage your money. That’s why it’s smart to build some flexibility into whatever strategy you choose.

This article originally appeared on GOBankingRates.com : Ramit Sethi: 2 Things To Consider When You Want To Invest but Have a Mortgage