Personal Finance

Should You Buy a Rental Property If You Have Existing Debt?

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Real estate often plays a catalytic role in improving finances and helping families achieve financial freedom. But if you already have existing debt on the books, you need to do your due diligence prior to taking on any more.

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Good Debt vs. Bad Debt

Before diving too deep into the discussion of whether or not it’s smart to invest in rental properties when you have existing debt, it’s important that we discuss the nuances of debt. In particular, we need to examine the difference between what financial advisors call “good debt” and “bad debt.”

Good debt is generally considered debt that you have against an appreciating asset—such as a house or business. Ideally, this debt creates cash flow for you. At the very least, the asset’s value appreciates over time and puts you in a stronger financial situation.

Bad debt is debt that you have against things like credit cards, car loans, and student loans. With bad debt, there is no appreciating asset. There also tend to be high interest rates, which makes it easy to fall behind on payments.

As the old saying goes, good debt will make you rich, while bad debt will make you poor. This is obviously an oversimplification, but you get the picture.

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Related: How Debt & Taxes Make the Rich Richer and the Poor Poorer

Investing in Real Estate With Debt

Very few Americans are totally debt-free. There are plenty of people who have gotten rid of their bad debt, but even those people typically have some good debt on the books. Thus the question arises: Can or should you invest in real estate while in debt?

The answer to this question isn’t as straightforward as you may like. While you certainly can, you’ll have to do some careful analysis to determine whether or not you should.

For starters, if you’re drowning in bad debt—i.e., credit cards, vehicles, and student loans—it’s not smart to think about adding more debt to the equation (even when it’s good debt). Your money is much better spent paying down these debts and digging yourself out of the hole you’re in.

But what about those who have very small amounts of bad debt or strictly good debt? This is where the discussion gets interesting.

Before getting too far along in your research, you'll need to make sure you even have the option of bringing on more debt. While lenders don't require you to have zero debt to qualify for a loan, they do want to see your debt-to-income (DTI) ratio to understand how much of your monthly income is going toward debt.

Related: The Dave Ramsey Dilemma: Should Real Estate Investors Really Avoid Using Debt?

“Lenders care about your DTI ratio because they want to make sure you have enough available income to cover your existing debts plus the mortgage,” RISE explains. “In other words, they are trying to determine your ability to repay the loan.”

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For a first home, the maximum DTI lenders are comfortable with is usually somewhere in the range of 36 to 50 percent. For a real estate investment or second mortgage, that number is probably a lot closer to 20 percent.

If the numbers line up and you think your finances will qualify you to buy a rental property, the next thing to think about is the practicality of making a deal.

The biggest pro to investing in real estate is that it provides you with additional cash flow. This money can then be used to pay down debt, which accelerates your ability to build wealth. Of course, there’s always the downside of having vacancies in your property or experiencing an economic collapse that kills property values and leaves you over-leveraged.

The biggest downside to investing in real estate when you’re already in debt is that your monthly payments only increase. This leaves you with less discretionary money and hurts your flexibility in the short-run. It also enhances your stress, since you’re only one problem away from a total disaster.

It’s a Personal Decision

At the end of the day, it’s impossible for someone to tell you whether or not you should invest in real estate while carrying existing debt. In some situations, the answer is clear. However, most instances require lots of research and due diligence.

Make sure you spend plenty of time analyzing the details of any deal before proceeding. Wealth building is a slow and steady game—don’t rush it.

Questions? Comments?

Weigh in below!

Larry is an independent, full-time writer and consultant. His writing covers a broad range of topics including business, investment and technology. His contributions include Entrepreneur Media, TechCrunch, and Inc.com. When he is not writing, Larry assists both entrepreneurs and mid-market businesses in optimizing strategies for growth, cost cutting, and operational optimization. As an avid real estate investor, Larry cut his teeth in the early 2000s buying land and small single family properties. He has since acquired and flipped over 30 parcels and small homes across the United States. While Larry’s real estate investing experience is a side passion, he will affirm his experience and know-how in real estate investing is derived more from his failures than his successes.
    Dave Rav from Summerville, SC
    Replied over 2 years ago
    The answer to your question is a resounding “yes!” Of course, as you alluded to, one needs to analyze their existing debt situation and have a plan for the many possible scenarios of having a rental- covering the spectrum from fronting $ for vacancies to capital improvements. And then, you could always have the unexpected happen in life… But waiting until one is completely debt free until investing in RE is a huge disservice to their financial growth and independence
    Nathan G. Real Estate Broker from Cody, WY
    Replied over 2 years ago
    When most people talk about debt, they are talking about personal debt like credit cards or car loans. I can’t believe the number of people in the forums wanting to start investing while still carrying heavy “bad” debt or with terrible credit. I believe an investment plan requires a solid foundation of financial responsibility. One proves financial responsibility by removing all personal debt, establishing good credit, and saving up a reserve fund. Once that foundation is established, then they can invest and take on risk.
    Shannon Goldsmith Investor from Los Angeles, CA
    Replied 2 months ago
    Agreed, Nathan. While taking on mortgages for rental properties may seem like "good debt", it's also taking on risk. And managing that risk with a balance between growth and debt pay-down is the best way to go. Ask anyone who lost their portfolios in the Great Recession due to having too much "good debt". A good strategy I learned from my mentor is to focus on rapid growth one year, then the next rapid debt pay-down, then rapid growth the next, etc. I have an awesome financial tool that I use myself to do the rapid debt pay-down piece. I've also helped other investors by introducing them to it. It helps you pay off your mortgages and all other types of debt in as little as 5 to 7 years, without changing your budget or your lifestyle. It also helps you gear up for your growth phase by assisting with down payment savings, etc. It's been a game-changer for me and for the investors I've shown it to.
    Rob Cook from Powell, WY
    Replied over 2 years ago
    Exactly Nathan. Having a 6 month cash reserve is crucial to tide you thru a bad time without losing your credit and investment. Tortoise and Hare. Plenty of Old pilots, and plenty of Bold pilots, but not many Old Bold Pilots! 2 steps forward and 3 steps back is NOT the way to growth or financial independence. But trying to either 1) borrow your way out of debt, or 2) gamble your way to financial independence, are both ill advised paths. Better to get your finances under control, and build that foundation as you stated, before diving in to the game, half-cocked. Yes, people gamble and win, but there is a reason the house always wins in the long term. People get lucky, and hit the timing right. But gambling, luck, and a cavalier attitude and approach is more likely to hurt you in the long run. As I learned in Stock Trading, “missed money is better than Lost money,” meaning, better to pass on a trade that is not high probability to win, than to “try it” and end up with the odds against you. Sara in the comment above appears to have “won” in her gamble, and I have done the same. But remember, there are many more stories of sad outcomes, such as those who bought heavily in 2007 as if there were no way to lose. They had “won” for years until they didn’t.
    Sara S. Rental Property Investor from Des Moines, IA
    Replied over 2 years ago
    I guess I’ll be one of those people who started investing while carrying heavy bad debt but I have terrific credit and a deep credit line. I probably got lucky but it’s working out great! I currently owe about $100,000 between credit cards, cars, home improvement loans, and student loans, all 4.5% interest or less. Out of college, I spent 3 years chasing the Dave Ramsey method, crawling to get anywhere on the debt while missing out completely on the market and real estate gains of 2011-2014. In 2014, I realized the quickest way for me to pay off the bad debt was get other people to pay it off for me. I stopped renting and bought a house with 0 down, rented out 2 of the 4 rooms to friends, 2 years later I bought a new house with 5% down and rented out that 1st house. This past summer I just bought another house to move into, renting out the previous one. In 2016, I stopped paying more than the minimum payments to my debt and started putting all my extra income into maxing out my 401k and a roth IRA. If I liquidated everything today, I’d probably break even, no bad debt but also no retirement. I’m waiting til summer 2020. Then I will sell both rentals, pay off ALL of my debt in one sweep about the same time my 401k will clear 6 figures. I think it was a brilliant plan. A single mom making less than $70k/yr but in just over 5 years I will have increased my net worth by almost $275,000! It’s not how much you make, it’s how much you keep.
    Rob Cook from Powell, WY
    Replied over 2 years ago
    Sara, congrats! Now take the “gift” luck provided you and move to the next level, conservatively and keep it going! That will make you a real winner!
    Reza Hosseini from Arlington, Massachusetts
    Replied over 2 years ago
    Inspirational story Sara! This approach may not be everyone’s cup of tea but it clearly shows how much can be accomplished with some foresight and planning and a tremendous amount of guts. Cudos!
    Bob E. from Queen Creek, Arizona
    Replied 3 months ago
    Now that we are into 2020 how did things work out?
    Jessica Renard Real Estate Agent from Hainesport, NJ
    Replied over 2 years ago
    Commend your courage, too. Always a puzzle, to pull together and make fuller, and you need that spirit to keep it that way. I like a person that looks straight at me, eyes unveiled, not bracing for the flicks already making their way back to them. Un-tired can matter. Markets change fast. We must prioritize plans. We must build reputations directly. And we must weather all market tendencies.
    Nicole Heasley Real Estate Consultant from Youngstown, OH
    Replied over 2 years ago
    House hacking and rental income has made it easier to pay down my existing debt.
    Brad Shepherd Syndicator from Austin, TX
    Replied about 1 year ago
    So many people these days complaining about their student loan debt (as if it just magically happened to them). I can't think of a better way to tackle that debt than with some solid real estate investments.
    Robert Ross Lender from Tulsa, OK
    Replied 3 months ago
    “ For a first home, the maximum DTI lenders are comfortable with is usually somewhere in the range of 36 to 50 percent. For a real estate investment or second mortgage, that number is probably a lot closer to 20 percent.” Wondering if 20% is a typo where 20% is meant for down payment? If not, this is incorrect. I lead a larger bank based acquirer if mortgage loans and see total DTIs up to 45 and 50% for both government backed loans and second mortgages. What really matters is residual cash flow in those instances anyway, not the just the ratios. Personal experience is that if you are saving money and are comfortable covering your obligations, get started in investing. The tax deductions (many times) will allow you to adjust your w4 deductions to get more of your income back each pay period which becomes a virtuous cycle in paying debt and amassing wealth. Thought provoking article though! Thank you for writing it!
    Susan Maneck Investor from Jackson, Mississippi
    Replied 3 months ago
    Everyone keeps calling credit card debt 'bad debt' but is it necessarily? Right now I have nearly 30K in credit card debt but it doesn't bother me. Why? They are all at zero percent interest. Yes, that will expire in which case I will either pay it off or transfer it over to another card. Yes, I generally pay a transfer fee, rarely more than 3%. Where else can I get unsecured credit for that. It was because of credit cards that I was able to buy so many houses and then repair them. Yes, right now credit is a lot tighter but if I need to pay them off, thanks to my rental income I can. I don't think there is any such thing as bad credit or good credit. To my way of thinking there is simply low interest rates and high interest rates. I don't want to pay the latter.
    Michael P. Lindekugel Real Estate Broker from Seattle, WA
    Replied 3 months ago
    for many people it is personal to own assets debt free. it can put into simple finance, economic, and accounting perspective for decision analysis. cash flow from an investment is nothing more than interest received on an investment. it is a cash flow received on the cash flow paid to acquire the asset. Interest income. When your after tax investment interest rate is higher than the after tax debt interest rate paid, then it beneficial to contribute additional or excess cash flow to acquiring more assets. The reverse is true. when the after tax interest rate paid is higher than the investment interest rate recieved, then it is beneficial to pay down the unpaid principal of the loan. There is a real opportunity cost for not following.
    Jessamyn Smith
    Replied 18 days ago
    I'm trying to answer this very question right now for a student loan I have. I pay some on my student loan as well as some into my investment savings each paycheck. What payments did you mean in the 3rd to last paragraph when you said "your monthly payments only increase"? Your total personal expenses? "your monthly payments only increase. This leaves you with less discretionary money and hurts your flexibility in the short-run." That seems like the opposite of what you said in the previous paragraph: "The biggest pro to investing in real estate is that it provides you with additional cash flow. This money can then be used to pay down debt, which accelerates your ability to build wealth."