Hey,

This week I got an interesting question from a couple in their mid-30’s with no kids. They live in Houston, Texas and just bought a house with a 7.5% interest rate.

They asked me:

Should we invest — or pay off our mortgage faster?

Check out their CSP and my thoughts below.

“Am I going to have enough?”

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“Should we pay off our mortgage or invest?”

Now let’s get into this week’s Conscious Spending Plan. Here are some details about this week’s couple:

• My husband (36M) & I (34F) live in Houston, TX with no kids
• We recently bought a house and we find ourselves spending a lot of money towards it
• We have a 7.5% interest rate on our mortgage.
• We max out our 401(k)
• Should we pay off the mortgage faster or invest?

I'm going to tell you right off the bat that the answer to this question is based on two things: math and psychology.

The math

If the interest rate is around 6% or higher, mathematically, it probably makes sense to pay off the mortgage faster. If it's lower, it makes no sense to pay it off faster. In fact, you should stretch that thing out for as long as humanly possible. That's the math part.

This is called opportunity cost. You could take the money that you would otherwise be paying off your mortgage faster and put it in an index fund. Over the course of a long period of time, you can reasonably expect to make about 7% to 8% on that money, factoring in inflation.

They have a 7.5% interest rate. Mathematically, they're probably doing the right thing by paying it off faster — but, of course, we need to look deeper.

The psychology

Now the psychology part. The psychology of some people is that they just hate debt. They think it makes them morally irresponsible. It feels like something is choking them. I can sit here and show them math all day long and they go, "Yeah, yeah, yeah, whatever, I hate debt." If they understand that, for example, paying off a 3% mortgage 15 years early will cost them literally hundreds of thousands of dollars that they could have made by investing that money, and they go, "I don't care. I just want to be rid of debt," I say, "Fine, go ahead."

Not everything in your Rich Life is about the numbers, but you need to understand both the numbers and the psychology, especially on massive decisions like this.

So let's take a look at their details.

Net worth

• Their gross annual income is $334,000 in Houston, Texas. With no kids to pay for, that's a lot of money.
• How come they only have $111,000 in investments if their income is $300,000+? That's not good.
• Savings are higher than investments at $114,000, which you don't see too often, especially with high-income people who tend to invest.
• Their debt is the house.

Income

• Again, their income is a lot at $334,000 per year.
• You can see that they are contributing a lot to their 401(k) because the net is significantly below the gross. That's good.

Fixed costs

• Fixed costs are 76%. This makes me uncomfortable. If they’re making $334,000 in Houston, Texas, it's a little surprising that their fixed costs would be so high.
• Let's talk about it. Their mortgage and utilities are 24%. That's not bad. It's towards the higher end of the 28% threshold I recommend, but you have to take into account that this isn't a couple making $135,000. They're making $300,000+. So they're spending a lot, and that really comes down to their interest rate. They're paying a ton in interest. They're going to pay hundreds of thousands of dollars over the course of 30 years.
• They're paying an extra $1,113 per month on their mortgage.
• Groceries are at $1,500 for two people. I'm not the grocery Grinch, but there's a number, a magical number, almost like November 5th, 1955 in Back to the Future, where almost every single person, regardless of how big their family is or where they live, spends around $800 to $1,200 a month. This couple spends even more, and they have no kids!
• Clothing is $300 a month.
• Home décor is $2,000 a month.
• Subscriptions are $440
• So they're basically living like they make more money than they currently have. Just like most Americans. But in this case, they're kind of living like they make around $500,000 or so — and they don't.

Investments

• Monthly investments are at $0.
• They said they max out their 401K, but I don't know if that's one or two people. That's kind of important. (Readers, in the future please put that information in here when you write in.)

Savings

• Savings at 14%. They don't need to save more for an emergency fund because they already have 12 months of expenses saved up.
• They're saving for home repairs. That's good.
• $2,000 a month for vacations. Great. I have no problem with that.

Guilt-free spending

• Guilt-free spending is at 10%.

Overall

• They're spending a lot of money on their house. Like, a lot. You all get mad at me because I tell you just maybe, possibly consider running the numbers on the biggest purchase of your life, and everybody comes after me with pitchforks, saying “Ramit says: ‘Don't buy a house’!" I never said that! I just said “Run the numbers!”
• Now let’s see how much they’ll have at retirement if they continue as they are now…
• They currently have $111,574 invested. Let’s say they’ll invest an additional $25,000 yearly. 30 years to grow at 7% — they're going to have $3.3 million plus a paid-off house. That's not bad. They're going to have roughly $135,000 a year from their investments. Of course, they'll also have social security, and they won't have to be paying housing costs if they stay in this house. Overall, that's a solid, solid retirement.

• I always default to investing a little bit more early on for a couple of reasons:
  
  
  • Compounding. If you can start investing even an extra $5,000 or $10,000 per year in your thirties, that turns into a staggeringly huge amount later in life.
  • When you automate it, you never miss it. You will just simply not think about it. Those are the primary reasons that I like to invest early and aggressively. For this couple, if their money dial is home decor, and they’re like, "I freakin' love it," then okay, they can keep it. Just understand the trade-offs and understand that they really should not have 76% in fixed cost. That's unhealthy. That means probably if one of them loses their job, they’re going to be in trouble. Luckily, they have a 12-month emergency fund, but why take the risk? At $334,000, they should be comfortable.
• So that's how I would think about it. Again, I'm just tweaking to show you what I would do. It's really your life.
  
  
• Now going back to the original question: Should we invest or pay off the mortgage? My answer is both.
  
  
  • Mathematically, it makes a lot of sense to pay off the mortgage. You do want to remember that there's more to your Rich Life than just math.
  • There's also psychology — like do you hate debt, etc? But at a 7.5% interest rate, which is a fairly high interest rate, putting money towards your debt would be great. Putting money in investments would also be great.
• Good luck and thank you for writing in.

P.S. Join me live in Seattle!

Over the last few months, I’ve hosted live events in NYC, Boston, Philly, and San Diego. I’ve gotten to talk to couples — LIVE on stage — about their money psychology, salary, debt, spending, and saving. I’m so grateful for the I Will Teach You To Be Rich audience.

Join me for my next West Coast tour stop in Seattle, WA on Thurs, July 18th. Get tickets here.

P.P.S. New podcast: “I work & watch my infant FT b/c we can’t afford childcare”

This week I talk to James (42) and Nicole (44). They just had a second baby — but they spend 90% of what they make and struggle to afford childcare. With Nicole’s maternity leave ending, she’s wondering how she will balance work and taking care of an infant at the same time. Watch the full conversation here.