Personal Finance

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

Expertise: Landlording & Rental Properties, Real Estate Investing Basics, Personal Finance, Real Estate News & Commentary, Business Management, Real Estate Deal Analysis & Advice, Real Estate Marketing, Mortgages & Creative Financing
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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.


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/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.”

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
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    Dave Rav from Summerville, SC
    Replied almost 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 almost 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.
    Rob Cook Real Estate Entrepreneur & Coach from Powell, Wyoming
    Replied almost 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 almost 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 Real Estate Entrepreneur & Coach from Powell, Wyoming
    Replied almost 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 almost 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!
    Jessica Renard Real Estate Agent from Hainesport, NJ
    Replied almost 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 almost 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 9 months 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.