Student loans or investment property

171 Replies

@Nathan Hall I've never tested the theory. Poor credit for one. Then on to a collections agency I'd imagine. Plus the interest will continue to accumulate. Then you'll be paying interest on the interest accumulated. The price goes up. You can defer them with approval, but they continue to gain additional interest to add to your balance. I've done that a few times. It's not good. 

Originally posted by @Steve B. :

@Rhonda McDaniel the reason student loans are not bankrupt-able is because they are federally backstopped by Sallie Mae & Freddie Mac. So the idea is that taxpayers shouldn’t be subsidizing people who default or bankrupt their loans. So if you want to default on your loan let’s agree to stop federally backing this program as we agree it’s stupid. Put the loan risk on the private market just like normal loans.

However it’s not ‘Trumo’ who is making you take these dumb loans, rather the same people you vote for are the exact people causing the problem by demanding that the federal government insures this dumb loan program so people can pursue 100k advanced pottery degrees. The same people you vote for are all about letting you default on taxpayers backed loans but those same clowns want to keep this broken system in place.

 @Steve B. good to know for the next vote. It is a broken system. Although I'm thankful for my education. 

Ultimately it's up to you. If you can get approved for a good loan, I'd definitely invest. Debt that makes you money is fine, in my opinion.

Only thing I'd say is try like heck to get a multifamily, not a single family.

Pay down the loans! The investment decisions that you will make when those loans are gone will be significantly different than the decisions you make with that weight hanging around your neck. The potential returns on investment property, when you adjust for the risk you are taking on, won't beat 6%. I know this sounds like Dave Ramsey, as everyone has mentioned, you've got to get out from under that debt first. Your future self will thank you. 

@Ashley Gish - can you do a combination? I'm assuming those student loans are separate payments so if you could find a way to buy a rental property and pay off a few of the loans that potentially have the highest payment you get the best of both worlds. Essentially if you pay a loan off that costs you $200/month, then your personal cash flow increases by that same $200/month. That can help you feel more comfortable with your finances and save that $200 for investing or paying another loan off to increase your cash flow.

Keep in mind paying off the loan does help increase your personal cash flow but you lose out on the other benefits of real estate such as depreciation, loan paydown and appreciation. That's why I would try for both. Buy one good cash flowing rental property and if possible pay 1-2 loans with high payments. Look at the return on your cash spent. If you pay $10,000 for a loan and increase your cash flow by $100 that's a 10% cash on cash return. You can achieve much higher with real estate but I know what it's like toy have student loans looming so I'd try to balance it out.

I didn't read every post but if it hasn't been mentioned house hacking also will allow you great cash on cash return because you don't have to put down a ton of your own cash to increase your cash flow and after one year move into something else for a low down payment and now you have a rental property.

@Ashley Gish

From what I've learned this far, I would look at a duplex and live in one half. If you have all this debt but really want to get in the game, that might make sense for you.

If you find the right property and the numbers make sense, you may be able to live very very cheap, if not for free while your tenant is paying the mortgage. Then you can start attacking that loan with the money you're saving.

-I will say, I just paid off my student loans ($70k+ ) and it is such a relief and I feel more comfortable taking on new investments now that it's over.

-Definitely listen to Dave Ramsey, he has a really good outlook on money, however, he probably wouldnt advise in any investing with all that debt.

I could be missing a huge point here but so feel like you can definitely make this work if you're willing to live below your means, ideally not downtown Portland, and consolidate that debt.

Good luck!

Dang, those interest rates are brutal! If you can find an investment that pays more than 7-8% and is worth the stress of such large student debts, personal opinion would be to invest the money. At the same time, being able to pay off the debt may give you far more in value due to piece of mind rather than having to stress about payments for the next 20+ years. Also, depends on your income level. Are you guys making enough money to not have to stress about the loan and potentially having a vacant rental unit.

As many other have said, househacking seems like a great fit in that you can get your mortgage paid for while focusing on paying of the school loans. Best of luck!

@Ashley Gish

Reading through these comments it seems like an important point is being missed.

The amount of debt you have is meaningless without knowing about other things like income and assets. You could have 200k in debt and still be in a healthy financial position depending on your income. Don't worry about the comments from people who automatically assume 200k in debt is bad.

In terms of your decision to pay debt or buy property. The best choice depends on the returns you will get. By paying down the loan you're putting those dollars to work at 6.8 to 7.2%. Not a bad return actually. But if you can put those dollars into a property that returns a higher rate over the same time period (including capital expenditures over the years), then the rental is a better financial decisions. The challenge is finding a property that will offer the return you need.

Also, some people have mentioned refinancing your debt. That's a good idea. You can probably get a much better rate.

Good Afternoon!

Personally, I'm a big fan of the Dave Ramsey model. I'd recommend going through his plan and pay off your debt first. After all, reducing payments is, essentially, increasing your usable income every month.

Dave has a list of "Baby Steps" that will help you get moving in the right direction.

Good luck in your endeavors,

@Ashley Gish - I would say, if you have the cash for the down-payment, you should get in to real estate. Especially, income generating real estate will help you in pay some of your debt. Even if you use your cash to buy a house to avoid renting, it will help you to build equity (as long as mortgage payment is not larger than current rent). Also, have extra cash saved for unexpected expenses. 

Hi @Ashley Gish We are in a similar situation with about $135,000 in student loan debt and have a car (not at 0% interest). We rent our current apartment and decided to purchase a vacation rental. Everyone's situation is different but for us this makes sense. Our goal is to try to get to financial independence as quick as we can and for us this is the best way. We saved up for the down payment and took out a loan (not withdrawal) from my 401k for the renovations, which I'm sure others will come in and disagree with, but now we are about to cash out refinance (BRRRR method) and will have 20% equity into it (meaning no more PMI) AND we will have enough cash out for the downpayment + renovation costs for the next property. From my calculations we will be cash flowing higher than our monthly student loan payments from these properties. With 2 properties we will hopefully no longer be paying our student loans - others are for us.

Good luck - go for the investment property!

@Ashley Gish I graduated with $70k of student loan debt and personally felt that I would struggle to move forward financially unless the weight of my loans was off my shoulders.  I aggressively paid off my loans in 2 years and then moved forward into real estate investing. Maybe I could have invested earlier and lengthened my payoff to take advantage of better returns, but for me, my path was worth it purely from a mentality standpoint. I can't even explain how much more in control of my financial future I felt when I paid off that last loan. Once I started investing, I was at the point where I could begin to think about things like financial independence without having my loans in the back of my mind. So, I think the decision comes down to how much you feel the weight of your debt, and that's something only you can know. You could also consider refinancing or at least paying off the higher interest loans in the near term. Good luck!

@Ashley Gish I would sit down and tackle any private student loans first. I wouldn't worry to much about any federal student loans until you have the private ones taken care of. 

Also, if your loans are structured like mine then you have multiple individual loans. What I do is put my focus on the smallest student loan out of the bunch. Snowball it from there. I have one loan that is now paid down to around $3,500. I'm excited because the monthly payment on it is $145/month. Once I get it paid off I will take the $145/month and put it towards the new smallest loan. 

Be careful re-financing student loans. If you currently have a bunch of small individual loans then I would not refinance. As I said, you can focus and pay them off one at a time. Every time you pay one of them off you are opening up more cash flow. If you re-finance them they will all go in to one big loan. 

I like knowing that I can pay off $3,500 and open up another $145/month in cash flow. If I had re-financed then I wouldn't have that option. My wife and I have already paid off a good portion of our student loans by using this method. 

Best of luck to you!

PS- Keep in mind you don't have to pay off all of your student loans before investing. Just pay off enough to where you are comfortable making the student loan payment as well as investing. Maybe you are already at that point. Kind of depends on how much money you guys are making with your W2 job. Every situation is unique. There's not really a right/wrong answer imo. 

@Ashley Gish , if I were in your situation I would give the Dave Ramsey stuff a hard look before moving forward. At the very least pick up his Total Money Makeover and consider taking his 9 week course with your husband. The logic is sound even though most of us here disagree with his philosophy about debt at a certain point.

His basic program:

1. Get on the same page as your husband regarding attitude toward debt, your plans going forward, and what each of your pressure points are re money.

2. Get on a monthly budget that you both agree to, both actually buy into, and follow

3. Get your insurance and estate planning in order. Especially having the right kind and amounts of life insurance and planning in place in case you and/or your husband die or become disabled.

4. Pay off your consumer debt (including student loans) smallest to largest

5. Have a 3-6 month personal emergency fund

6. Invest for retirement and kids college/pay off primary residence

The first three steps are, IMHO, the most important and his presentation of them is the best I've seen-- they're also the ones that financial advisors (online and in person) tend to leave out.

He also talks bluntly about the risk of the various types of debt-- which most people who advocate for them either don't or minimize. Personally, I want to know the risk upfront and don't want it sugarcoated, minimized, or spun in any way. That way I feel I'm in the best position to make an informed decision. Also keep in mind that Dave's advise is a little different for high income earners than it is for everyone else. 

In my case, eliminating consumer debt and having a personal emergency fund in place eliminated a lot of stress I didn't know I was carrying. During the federal government 'shut down' (which had a larger than normal effect in the DC area) early this year, and a lot of my friends were in panic mode, I was fine. That wouldn't have been the case a year earlier.

@Ashley Gish I would say target your highest interest rate loans - be it student loan and start paying them off. Education is expensive and if it’s allowing you to have well paying job, why not? I know people here would argue but because of my education, I started making good money and I was able to invest that money into real estate. Good luck!

@David Wallace thanks David! I appreciate your logic in being able to see the bigger Financial picture. And thank you for your advice. Despite all of the negative comments on this thread there have been a few people like yourself who have been incredibly helpful. In fact I’ve decided to pay off everything above 5% and I was able to start the process of refinancing the remainder of the loans at 2.5%. Then will still be able to have 20% + down to start looking at properties. Feels like a good middle ground approach. We also have a short term rental permit for our home which is in a great vacation area so hoping to use that more. 


@George Gammon this is a brilliant explanation. I'm surprised that there are still proponents of Dave Ramsey's philosophy when it is obvious that an investment in real estate yields far greater benefits long term.

If the expense of the debt isn't a problem, increase the top line!!

@Joel Johnson @Armin Nazarinia @Christian Rojmar  @Tiffany Faulknor  @Derrick E. @Mac F. @Alpesh Parmar @Nate Bell @Alonso Escalante @Marcus Johnson @Ashley Gish @Jonathon Weber @Shahene Nili @Derek Joyner

I'm really concerned with the lack of understanding on BP in general, especially on this thread.  

I want to say upfront that I mean absolutely no disrespect to anyone on this thread, but I feel a moral obligation to try to "show the light" to as many people as possible.  For many years I thought Paul Krugman had destroyed more American minds than anyone else...I'm now thoroughly convinced it's Dave Ramsey. 

(We'll assume there's not a 30% chance the student loans will be forgiven.)

First, the number one issue I see on this thread is people conflating rental property with a bond, annuity, or any fixed income instrument.  Meaning, you take money from your bank account, buy the fixed income instrument, you get a fixed monthly payment, and in the end you get your principle back along with the interest.  

The reason people make this mental error is they don't consider/understand inflation.  In other words, over the long term, rents go up, the debt payments stay the same.  See chart

As an example, lets say there's a 2.5% annual rate of inflation.  You buy a 20 year, interest only, fixed income asset for 100k, with annual 10% interest.  At the end of the 20 years you have 300k (200k interest + 100k principle.)   

THAT IS NOT HOW RENTAL PROPERTIES WORK.

If you buy a 100k rental property, with a yield of 10%, and there's 2.5% inflation, at the end of the 20 years you have approx 363k.  Why is there a 63k difference?  Because inflation increased yield by 2.5% per year.  In first example, inflation had no effect on yield because the rate of return is fixed.  

Just to drive this home let's use a different example.  

Many on this thread have suggested @Ashley Gish would need a higher rate of return on the investment than the rate of return on her student loans.  Again making the mistake of assuming a 100k rental property is the same as having 100k in the bank.

Obviously the 100k in the bank would need to have a higher interest rate than the rate on the student loans, or if both rates were the same it would be a wash, or if the rate on the bank account was lower, it would be better to pay off the loans.  

But what if the interest rate on the 100k in the bank increased by 2.5% per year?  (interest rate x .025 not plus 2.5). Assuming both the cash in the bank and the student loans started with the same rate, will the cash in the bank make more than the amount of interest paid on the student loans?  YES!  

So that's how the cash flow works, now we'll discuss the price of the fixed rate asset vs. a rental property.  In other words, the capital gains. 

Again assuming 2.5% annual inflation, and assuming you put 100k in a bank account, at the end of 20 years what would the value of your original 100k be?  Answer: 100k.  

Under these same conditions, what would the value of your 100k rental property be?  Answer: 163k.  

Next, remember the renter is paying the mortgage.  We haven't even discussed how debt increases returns.  But I'll skip that for now, and go straight into a final example which will undoubtedly put an end to the Dave Ramsey insanity once and for all.

In this hypothetical let's say you have 200k in student loans and 200k in cash.  Option #1 is paying off the debt so you would have zero cash and zero debt.  Option #2 is putting 200k down on 500k in rental properties, using 30 year fixed rate debt at 5%, and keeping the 200k in student loan debt.  

Now let's assume the positive cash flow collected from the properties is the exact amount as the monthly student loan payments.  And the total rent and total student loan payment were both $1500 a month.  

With a average inflation rate of 2.5% over 20 years, at the end of 20 years this is how the 2 options would play out.

Option #1 -  0 cash and 0 debt

Option #2 - 114k in cash, 673k in equity, and 0 debt

Which would you choose?  It's literally the difference between being completely broke and almost being a millionaire.  

So how did I get those numbers?  Remember the 2.5% inflation rate.  If rent increased by 2.5% per year for 20 years it would go from $1500 to $2457.  Of course $1500 goes to student loan payments but the difference, over 240 months (20 years) of rent payments is approx 114k. 

How about the equity?  You start with 200k in equity, the renters pay off 154k of the original loan amount, and the 500k in rental properties goes up each year with inflation (2.5%) so at the end of the 20 years the value of the properties is 819k, a 319k difference.  So 200k + 154k + 319k = 673k

In all seriousness arguing to pay off the student loans now is akin to arguing for the flat earth theory...it's truly that level of irrational thinking.  

And I want to stress this is not my opinion, this is math, plain and simple.  If you dispute the conclusion you're not disagreeing with me, you're disagreeing with math.  

I want to reiterate that I mean NO disrespect to anyone on this thread.  I'm in no way doing this to be negative, or heckle people, I'm only doing this because I want everyone on BP to understand how inflation affects real estate investing.  And how dangerous the ideas of Dave Ramsey are to real estate investors.  

Debt for consumption is bad...absolutely 100%! 

Debt for productive investment is very good...100%! 

I leave you with food for though.  If debt on net balance is negative, how and why does the world have fractional reserve banking? And what would the world wide standard of living be without fractional reserve banking?  Or simply compare the standard of living in countries that have a developed credit/banking system and those that don't.  

George

Originally posted by @George Gammon :

@Joel Johnson @Armin Nazarinia @Christian Rojmar  @Tiffany Faulknor  @Derrick E. @Mac F. @Alpesh Parmar @Nate Bell @Alonso Escalante @Marcus Johnson @Ashley Gish @Jonathon Weber @Shahene Nili @Derek Joyner

I'm really concerned with the lack of understanding on BP in general, especially on this thread.  

I want to say upfront that I mean absolutely no disrespect to anyone on this thread, but I feel a moral obligation to try to "show the light" to as many people as possible.  For many years I thought Paul Krugman had destroyed more American minds than anyone else...I'm now thoroughly convinced it's Dave Ramsey. 

(We'll assume there's not a 30% chance the student loans will be forgiven.)

First, the number one issue I see on this thread is people conflating rental property with a bond, annuity, or any fixed income instrument.  Meaning, you take money from your bank account, buy the fixed income instrument, you get a fixed monthly payment, and in the end you get your principle back along with the interest.  

The reason people make this mental error is they don't consider/understand inflation.  In other words, over the long term, rents go up, the debt payments stay the same.  See chart

As an example, lets say there's a 2.5% annual rate of inflation.  You buy a 20 year, interest only, fixed income asset for 100k, with annual 10% interest.  At the end of the 20 years you have 300k (200k interest + 100k principle.)   

THAT IS NOT HOW RENTAL PROPERTIES WORK.

If you buy a 100k rental property, with a yield of 10%, and there's 2.5% inflation, at the end of the 20 years you have approx 363k.  Why is there a 63k difference?  Because inflation increased yield by 2.5% per year.  In first example, inflation had no effect on yield because the rate of return is fixed.  

Just to drive this home let's use a different example.  

Many on this thread have suggested @Ashley Gish would need a higher rate of return on the investment than the rate of return on her student loans.  Again making the mistake of assuming a 100k rental property is the same as having 100k in the bank.

Obviously the 100k in the bank would need to have a higher interest rate than the rate on the student loans, or if both rates were the same it would be a wash, or if the rate on the bank account was lower, it would be better to pay off the loans.  

But what if the interest rate on the 100k in the bank increased by 2.5% per year?  (interest rate x .025 not plus 2.5). Assuming both the cash in the bank and the student loans started with the same rate, will the cash in the bank make more than the amount of interest paid on the student loans?  YES!  

So that's how the cash flow works, now we'll discuss the price of the fixed rate asset vs. a rental property.  In other words, the capital gains. 

Again assuming 2.5% annual inflation, and assuming you put 100k in a bank account, at the end of 20 years what would the value of your original 100k be?  Answer: 100k.  

Under these same conditions, what would the value of your 100k rental property be?  Answer: 163k.  

Next, remember the renter is paying the mortgage.  We haven't even discussed how debt increases returns.  But I'll skip that for now, and go straight into a final example which will undoubtedly put an end to the Dave Ramsey insanity once and for all.

In this hypothetical let's say you have 200k in student loans and 200k in cash.  Option #1 is paying off the debt so you would have zero cash and zero debt.  Option #2 is putting 200k down on 500k in rental properties, using 30 year fixed rate debt at 5%, and keeping the 200k in student loan debt.  

Now let's assume the positive cash flow collected from the properties is the exact amount as the monthly student loan payments.  And the total rent and total student loan payment was $1500 a month.  

With a average inflation rate of 2.5% over 20 years, at the end of 20 years this is how the 2 options would play out.

Option #1 -  0 cash and 0 debt

Option #2 - 114k in cash, 673k in equity, and 0 debt

Which would you choose?  It's literally the difference between being completely broke and almost being a millionaire.  

So how did I get those numbers?  Remember the 2.5% inflation rate.  If rent increased by 2.5% per year for 20 years it would go from $1500 to $2457.  Of course $1500 goes to student loan payments but the difference, over 240 months (20 years) of rent payments is approx 114k. 

How about the equity?  You start with 200k in equity, the renters pay off 154k of the original loan amount, and the 500k in rental properties goes up each year with inflation (2.5%) so at the end of the 20 years the value of the properties is 819k, a 319k difference.  So 200k + 154k + 319k = 673k

In all seriousness arguing to pay off the student loans now is akin to arguing for the flat earth theory...it's truly that level of irrational thinking.  

And I want to stress this is not my opinion, this is math, plain and simple.  If you dispute the conclusion you're not disagreeing with me, you're disagreeing with math.  

I want to reiterate that I mean NO disrespect to anyone on this thread.  I'm in no way doing this to be negative, or heckle people, I'm only doing this because I want everyone on BP to understand how inflation affects real estate investing.  And how dangerous the ideas of Dave Ramsey are to real estate investors.  

Debt for consumption is bad...absolutely 100%! 

Debt for productive investment is very good...100%! 

I leave you with food for though.  If debt on net balance is negative, how and why does the world have fractional reserve banking? And what would the world wide standard of living be without fractional reserve banking?  Or simply compare the standard of living in countries that have a developed credit/banking system and those that don't.  

George

Sir, I didn't say not to do a rental, a flip, or whatever else. My best friend is s CFO at a large company. I have also lived with a large student loan balance. Attacking the debt head on is very smart as long as the income grows at the same time.