Student loans or investment property

171 Replies

@George Gammon

I completely agree with "you can't argue with math " (I have a math degree). However we are not purely logics creatures and often make emotion driven financial decisions. There's a reason why people exit the stock market at the bottom despite all historical data and logic says to leave your money as it will bounce back.

@Ashley Gish I am doing all 3 recommendations I've seen.

1) With a nod to George's philosophy I take all windfall money (primary residence flip capital gains, W2 bonus, etc.) for my next reasn estate deal as the most LOGICAL use of my money.

2) I refinanced my remaining 68k @ 7% student debt last month down to a 5 year @ 3.64% (feel free to calculate your hourly income/ savings equivalent of the 3 hours I spent refinancing - I plan to pay off in 3 years regardless of term and rate, still save a couple thousand over the 3 years).

3) Reducing our lifestyle inflation (cutting expenses by living more intentionally) and using the extra money to throw at the student debt.

My own debt risk tolerance for bad debt (I consider any debt not tied to any non income producing asset or my primary imo) is low before I increase my good debt position with real estate. But if I pay off the student debt with the windfall money, we don't get the added life (financial) experience of not only living within our means but under our means. Those habits will pay dividends for the rest of our lives.

@George Gammon

@Ashley Gish

Apologies, didn't get to close that out.

Basically, for me, I see the logically fallacy in spreading out between my 1 & 3, but if all financial decisions were truly logic only, id be a very rich bachelor instead of a husband and father.

George if you really wanted to get wound up on the psychology of money vs the logic of money, I could have a separate conversation explaining why I'm attacking my student loans from a snowball and avalanche philosophy simultaneously! ;)

Best of luck Ashley and thanks for the good read George.

@George Gammon , maybe you can help me because I'm clearly missing a few things.

1. When has Dave Ramsey ever recommended buying fixed income assets?

2. When has Dave Ramsey ever recommended buying fixed annuities?

3. Who in this thread is against buying rental property as a way to build wealth? 

4. Why do you feel that net level of positive cash flow of $1500 a month on a 500k portfolio of properties with 40% down is reasonable, especially for novice investors? 

-------------------------------------

I thought I read this thread closely, and maybe I didn't-- but I haven't seen anyone here advocating Dave's preferred recommendation of buying property with cash. What I did see was people advocating paying off consumer debt and having adequate savings before investing in real estate. What I did see was people pointing out the risk of recourse consumer debt (especially student loans). In my case, I focused on Dave's advice regarding insurance and estate planning-- in part because I've lost far too many friends to cancer, war, and car wrecks who left people behind who loved and depended on them behind.

@Ashley Gish

Wow, hot thread! Great question, I’ve been wrestling with that too.

Not sure if you qualify for debt forgiveness program for federal loans, but if not, definitely refinance. I am not in a public/non profit occupation, so I refinanced from Fed grad loans at 6ish% to bank at 3.35%. Imagine putting $6k interest back in your pocket right away!

I read Dave Ramsey’s book Total Money Makeover last week and it made some really good points that made me think differently about some things than I had before. I strongly encourage you and your husband to read this perspective to aid your decision making process. (I got the book from my library at no cost)

All the best!

@George Gammon Great examples and certainly not feeling disrespected.

1) I respect that you are looking at it 100% from the financial side of things and I am not disagreeing with your math other than that you will have to pay capital gains tax at some point reducing that number depending on 1031 etc. However, I know many people that cannot function when debt is hanging over their head and while it may not be the best financial decision, paying of the debt sooner rather than later will give them piece of mind which is more valuable to them.

2) As for inflation and its effect on rental values, I am personally very concerned about the growing discrepancy between rents and income and something is going to have to give - i.e. is it reasonable for rent to continue growing with inflation or more while income is staying flat (in what seems to be best case scenario). I cannot see that scenario pan out... I would say the same for property values and how rapidly they are increasing compared to income. I would love to hear your thoughts on this because it worries me.

3) I have student loans that I pay absolute minimum on while investing in market which is providing compounded growth.

4) Reading back my poorly written comment,while it may sound like it, I am not saying that they should pay off debt ASAP unless it will give them piece of mind, and I am certainly not arguing that they should put any income into a savings account or an interest bearing note and let it sit. However, if debt is a concern, which it clearly is for this person, investing in the market with a return of 7-8% annually may be the better option due to the liquidity and not having to take on more debt (and you can leverage your position there as well if you want).

Ashley, 

Been there and great Q. See if you can get those rates reduced. What you want to consider is if the numbers make sense.. For example if you were to pay 5% on the 200k and your return upon consideration of ALL the costs of real estate is equal or greater than 8 percent using 200k, I would do it. It’s about the numbers. I would NEVER have ventured into real estate investment if I listened to nay-sayers. Be cautious, run your numbers. Mine were/ are ( student loans) at about 4 percent rounded up. So the return on the rentals  gives me money to pay them down quicker, plus I’ve had appreciation on the properties. So just weigh all angles. I did ask myself that 9-10 years ago. Best wishes. 

I suppose it all depends on which philosophy you follow. Dave Ramsey would say pay it off. Robert Kiyosaki would say invest in something that could pay it off for you. I tend to be of the latter camp, but that’s just me.

Just adding to the already great advice I’ve read. You definitely can do both with the right deal. I’m actually working on a multi family 100k down with hard money lender to get an all in at one Million dollars for 30 units. Avg rent 815. Arv 1.9 million. Getting a deal like this can take care of your debt but would you want to if you had another deal lined up similar or 3 times better than the 1st , which I do. So the short of it is, you can do it. Might want to see if you can leverage someone else’s experience and time if  you are bringing the equity.

@Ashley Gish I would invest in real estate that would compliment your career. Say if your a primary care , find a property that would cater to your practice . The property is a separate business right , rent it to your self , build a client base , hire or partner with another doctor , repeat the process . Then sell the real estate and practice , pay off your loan then retire .

Dont forget my comission...

@Ashley Gish

My suggestion would be to purchase a multifamily.

If you have enough cash you may be able to buy 2 - one with fha and one 20% down through traditional financing.

You can refinance your student loans. Banks are offering around 4.25% or so right now depending on your credit.

It obviously depends on your age and overall situation. But The rule of thumb when deciding to pay off student loans more aggressively vs invest, is that if you can earn more interest than what you would spend paying off the loan, invest the money instead.

The longer you wait to purchase properties, the longer you wait to pay them off and have some financial freedom.

Nothing really happens if you don’t pay off your student loans other than the fact that you have them.

If you can refinance over 10, 15, or even 20yrs, I don’t see anything wrong with it. Just accept that it’s a part of your everyday expenses.

But I wouldn’t wait to invest to pay off your student loans. Especially since you have a lump sum like that. Depending on what you do for work and your discipline with savings, it may be very difficult to save up enough to buy something anytime soon.

It seems like you guys are on the right track financially, and will be fine regardless, and I know idea of being free of debt is very attractive, but I think you will be much more greatful years down the line having purchased the property when it’s paid off and you have significant income coming in.

Oh and SCREEN your tenants, so you hopefully don’t have to do another renovation project just because of them - eviction history, credit, background. And actually talk to their previous landlord and get paystubs!

@George Gammon it is not a lack of understanding, it’s a lack of difference in opinion. I don’t disagree with your analysis but you are making some rather large assumptions and leaving out many factors about being a rental property owner, especially a first time owner.

You’re not wrong. Those who have said pay off the loans aren’t wrong. It’s a difference of opinion, and one that if you really dig into it could be thoroughly argued either way.

@Ashley Gish - First let me apologize on behalf of the judgmental and condescending people in this forum. I am SURE that is not the objective in the BP Forum!! Advice and opinion is what you asked for NOT JUDGEMENT!! As far as your student loans, go, I am in your same situation. Because you have had to take out student loans to obtain a career for yourself and your family does NOT make you a financially irresponsible (as someone in this post stated 😠) I would recommend doing what someone else in the forum recommended; do both. 😁 Consolidate your student loans into the lowest possible rate AND use some of the money to invest. As long as you are in a financially stable situation with everything else, the consolidation should also help and/or improve your credit score. Hope this helps!! 😊

@Marcus Johnson maybe I don't have much financial sense either. We (wife and I) had a combined income of about $75k when we both went back to school. We took on about $160k in debt, at roughly4.3% which is a burden we must bear. On the bright side, our household income has increased by over $140k annually. If something happens to my income stream I can replace it anywhere in the U.S. within 90 days as long as I am physically able. Small town, big city, doesn't matter. I felt that it was a reasonable course of action given the returns, risk profile and other options I had at the time.

If I can generate similar returns in my real estate pursuits I would consider it an overwhelming success.

I have wrestled with some of the same concerns as the original poster. I chose to handle mine by paying off about $30k of my grad school loans first, as those were at the highest rates (6% +/-). Anything under about 3% (undergrad loans) I'm going to stretch out as long as possible, as I suspect they are not even keeping up with inflation. Every year my income goes up, as does overall cost of living, but the payments on those loans stay the same. I suspect it's going to seem like a pretty insignificant burden by the time I'm making the last year of those payments. I am curious to know what you decide to do. Please keep us posted.

Originally posted by @Marcus Johnson :

@Ashley Gish

I find it amazing that someone could rack up 200k in student loan debt. I hope your lawyer or doctor job will allow you to pay off the loans quickly. Someone who takes out 200k in loans doesn’t have a lot of financial sense unless the return in investment is high. Pay off the loans and get control of your finances. You have no business investing in real estate until you hmget your finances in order.

Most dentists start 400-500 in the hole now. Wish I knew what that meant back then...

Originally posted by @Christian Rojmar :

@George Gammon Great examples and certainly not feeling disrespected.

1) I respect that you are looking at it 100% from the financial side of things and I am not disagreeing with your math other than that you will have to pay capital gains tax at some point reducing that number depending on 1031 etc. However, I know many people that cannot function when debt is hanging over their head and while it may not be the best financial decision, paying of the debt sooner rather than later will give them piece of mind which is more valuable to them.

2) As for inflation and its effect on rental values, I am personally very concerned about the growing discrepancy between rents and income and something is going to have to give - i.e. is it reasonable for rent to continue growing with inflation or more while income is staying flat (in what seems to be best case scenario). I cannot see that scenario pan out... I would say the same for property values and how rapidly they are increasing compared to income. I would love to hear your thoughts on this because it worries me.

3) I have student loans that I pay absolute minimum on while investing in market which is providing compounded growth.

4) Reading back my poorly written comment,while it may sound like it, I am not saying that they should pay off debt ASAP unless it will give them piece of mind, and I am certainly not arguing that they should put any income into a savings account or an interest bearing note and let it sit. However, if debt is a concern, which it clearly is for this person, investing in the market with a return of 7-8% annually may be the better option due to the liquidity and not having to take on more debt (and you can leverage your position there as well if you want).



Christian, thanks for the well written and thought out response.  You bring up a couple things I think are extremely important to address. 

1.  Some people can't function with debt over their heads.  In other words, it makes some people feel good to not have any debt, because they feel like they're taking less risk, and if taking less risk makes someone feel good or sleep well at night than it's worth it.  

If humans were rational this would hold merit because most would instinctively know probabilities/risk.  Unfortunately, humans are the opposite.  We are terrible at analyzing risk and probabilities.  

As an example some people have a fear of flying but they'll drive 2 hrs a day in traffic, often without a seat belt.  Or ask someone if they're more afraid of terrorists or catching a cold?  Mass shootings or falling off a ladder?  Hopefully these examples are rhetorical.  

Bottom line people really really suck at accessing risk.  And often, what makes us feel good, is actually far more risky.  

Many on this thread have suggested the original poster do what ever is going to make her feel best.  But isn't doing things that are uncomfortable because of cost/benefit part of what defines adult behavior?  Going to the gym, working extra hours, studying in college, waking up at 6am, admitting mistakes, personal discipline, etc.  If we never did anything uncomfortable because of a greater benefit in the future we'd all be 3 year olds.  

And then take this to its logical conclusion.  I'm sure everyone would admit there is a level of risk that exceeds the benefit of feeling good.  Would you tell a friend to eat a cheesecake everyday or smoke because it makes them feel good?  Of course not.  

So what it then boils down to is measuring the actually risk of taking 200k and paying off student loans opposed to investing in positive cash flow rentals with 30 year fixed rate debt at sub 4%, because it makes them feel good.  

In the prior post we established they'd lose around 800k...I think that qualifies as risk.  Next, by paying off the student loans the poster will be 100% reliant on a job and traditional retirement plan, call it social security and 401k.  (I'm assuming the poster never invests because of a continued irrational fear of debt).  So they're totally at the mercy of an employer, the stock and bond market, and the US economy.  

Remember how people are really bad at accessing risk.  Get a good job, 401k, no debt...what most would consider low risk, is actually extremely high risk.  Why?

The US is 23 trillion in debt (on balance sheet), we are the largest debtor nation in the history of the world, the US has a wildly inflated standard of living because of the USD status as world reserve currency, the stock market is at nose bleed levels, and the bond market has 15 trillion in NEGATIVE yielding debt.  Additionally, the US is 11 years into an economic expansion, the longest in history.  The next recession will come.  When?  We don't know, but based on history, sooner than later.  

In 2009 the world economy nearly imploded because of debt bubble.  Is debt lower or higher now?  Much higher.  The consumer debt bubble was merely transferred to a sovereign debt bubble.  What makes 2019 10x more dangerous than 2009?  In 2009 the private sector was bailed out by governments, in the next recession who bails out the governments?  

I could go on and on, but the bottom line is there's a very good chance a good paying job might not always be there.  There's a good chance a 401k won't be there.  There's a 100% mathematical certainty social security will not be there.  And there's also a good chance that rental property, in a linear market, in a good neighborhood, purchased with 30 year fixed rate debt, will be there...

So which is more risky?  Paying off the student loans or buying the investment property?  At the very least it's a toss up.  ;) 

I would argue it's much more risky to pay off the student loans, especially when you consider the loans maybe forgiven, therefore advising to pay them off because it would feel good, is similar to advising someone to smoke because it feels good.  


2.  And this is by far the most important topic you brought up.  Can rents increase if wages are flat?  I think you said you don't see this happening?  Again, this illustrates how little most understand inflation.  And I'm sorry to pick on you but it's imperative everyone gets this.  

You're comparing 2 completely different things.  Real (adjusted for inflation numbers) and Nominal (just numbers without an inflation adjustment.)  30 year fixed rate debt never changes, your first payment is the same as the last payment, it's a nominal number.  When you compare your debt payment to your income stream (rent) you have to compare apples to apples.  In other words, nominal numbers with nominal numbers.

What you're doing in your chart above is showing real (inflation adjusted numbers.) 

I know this get's really confusing, really fast, so let's use an example using your chart above.  According to your chart rents are 160% higher than they were in 1960 (in real terms.)  Wages are 120% higher (in real terms.)  A delta of 40%, which to your point, seem unsustainable at best, how could rents possibly go up?  At some point people can't afford the sky high rents.

But remember those are inflation adjusted numbers and the debt is nominal.  In other words real rents could come down while nominal rents could sky rocket.  How?  If the rate of inflation exceeds the rate of rents going up.  In other words, if rents are going up by 2% per year and inflation is 3% per year, real rents are going down while nominal rents are going up.  

Question:  Will a dollar buy more or less in 20 years?  If your answer is less, that's all that matters, rent's will be higher but the debt payments will be the same.  

Let's go back to your chart one more time.  Look at rents from 1970 to 1980.  Didn't go up that much right?  But when you run the numbers through and inflation calculator rent's more than doubled in nominal terms.  

Your chart uses inflation adjusted numbers but the debt doesn't adjust with inflation.  When you use nominal rents, with nominal debt, over 20 years, rent's will 100% of the time be higher.  

The bottom line:  

1.  Paying off student loans is NOT less risky than investing, in the way I outlined, and IMHO it is irresponsible to advise someone to do it anyway because it feels good. 

2.  When analyzing any investment make sure to compare real (inflation adjusted) numbers with real numbers and nominal numbers with nominal numbers...debt is nominal, so it must be compared with nominal rents, which over time, will always go up.   

Thanks again for your response, I hope I was able to shed some light on, at very least, how inflation works with debt.  It's crucial to making good investment decisions over the long term.   

George 

Originally posted by @Derrick E. :

@George Gammon Respectfully, you are not taking in to account DSCR/DTI with those student loan payments hanging over your head. I am paying off some of my student loans to open up more buying power down the road.

Derrick, thanks for your response.  Even with a 100% cash purchase, assuming 200k in student loans and 200k cash, they're much better off in 20 years financially.  They'd still have all the cash flow from inflation, the original 200k, the nominal/real appreciation of the asset, depreciation, and zero student loan debt.  

George  

@George Gammon

“So what it then boils down to is measuring the actually risk of taking 200k and paying off student loans opposed to investing in positive cash flow rentals with 30 year fixed rate debt at sub 4%, because it makes them feel good.”

I think you are missing the point people are making about “do what ever is going to make her feel best.”

The problem I see with your argument that it “boils down to measuring the [actual] risk of taking 200k and paying off student loans opposed to investing in positive cash flow rentals. . . because it makes them feel good” is that it is all about the financials. People simply value things differently. You assume that just because a person will be better of in the future based on math, that person will feel better down the road. Financially, yes, but happiness, enjoyment of life, etc. maybe not. I did not see her asking what makes most sense financially (but maybe that was inherent in her question) but more general, "what should I do?". For example, while working 15-hour days and not seeing my family, and living in a 500 sf apartment is the financially right decision, it is the wrong decision for me because I value time spent with my family way more than I value money. Same can hold true for stress/piece of mind.

“In the prior post we established they'd lose around 800k...I think that qualifies as risk.”

Frankly, I do not think we have established that they would lose 800k unless we make some extremely irrational assumptions that favor investing in RE. And don’t take me wrong, everyone on this site want to invest and believe investing in RE is the way to get out of the rat race but the numbers are not reality. For example:

  • You assume that they actually have $200,000 to invest right away;
  • You assume a first-time investor will find properties that will generate $1,500 monthly true cash flow on a $200,000 investment;
  • You assume that they will pay no tax on the cashflows from the investment;
  • You assume they will pay no capital tax on the sale of properties in future;
  • You do not factor in the risks of investing in RE rather than paying off debt;
  • You assume that they will pay off the debt completely rather than put at least some of the $200,000 in market which should conservatively generate 5% annually (which can be leveraged significantly just like RE). Even just $100k in market will generate ~$165,000 pre-tax in 20 years.

“What makes 2019 10x more dangerous than 2009? In 2009 the private sector was bailed out by governments, in the next recession who bails out the governments?”

While I certainly agree that a recession will happen eventually (probably sooner than later), you are talking about an event that will change the way we live today... I would probably buy gold if I believed this would happen. If you are thinking of a “normal” recession, then market will come back just like it did after 08-09, similarly to how the RE market came back.

2. And this is by far the most important topic you brought up. Can rents increase if wages are flat

This was very informative, helpful, and appreciated – but I am not sure it answered my concern? I am not talking about fixed debt v. rent but real rent v. real wages. If rent is going up by 5% per year, inflation by 5% and wages by 2%, real rent is staying flat while real wages is going down by 3%. The discrepancy between real wages and real rent is increasing rapidly – less people can afford housing. Same is true for home values.

Help me understand how “at some point people can’t afford the sky high rents” and “but remember those are inflation adjusted numbers and debt is nominal” have anything to do with my concern that real rent is increasing more rapidly than real wages?

My point, and again I may just be missing what you are saying, is that while $1 in real wages (accounted for inflation) was worth $1 in real rent in 1960, in 2014, $1 in wages is only worth $0.73 (if I am doing the math correctly – 120%/165%-1). Real income is not keeping up with real rent and something will have to give regardless of whether debt stays the same.

@Ashley Gish I never understood this type of forum post. What do you want people to tell you? You have 200k in debt, a car payment, a house payment. You have a lot of debt. Time to pay that off. It’s a risk free return. Real estate is not.

You need to not get so defensive when someone tells you what you don’t want to hear. It sounds like you already had your mind up when in reality the best thing to do is pay off the student loans.

I agree with @George Gammon that the purely logical answer is to buy a property that can help you pay off the student debt, BUT if I think back to when I had my first primary residence only (and a boatload of student debt)... there's no way that was a feasible possibility for me/us.   George's scenario also (if I read correctly) assumes that you have 200k in cash to buy a property that will cashflow well enough to assist with the debt from day one.

Don't get me wrong, IF you do have that cash in hand, I would follow George's recommendation 100%.  If you don't have that cash in hand... I would focus all my non-working time on refinancing that student loan debt to a decent rate before anything else (student loan refi, HELOC on your home, whatever best fits and gives you the best rate). That refi will simply buy you time and make sure you stop the bleeding and cauterize the wound, which will give you time to think logically about all things.

If at that point you can find an investment that cashflows enough to help pay down the debt from day one that's still a great option.  If not, I would (despite not being the purely logic based solution) put all energy and extra cash into paying down the student loan until you do find that perfect investment.

Most importantly...don't forget you can also tackle this from the other end.  
Everyone seems to spend all their time trying to figure out how to make/earn MORE, when many peoples life and portfolio would be best served by reducing expenses.  
Try to figure out how to reduce your monthly expenses in every possible way until you can get out from under this thing.  Get rid of the new car, rent a room to a (paying) roommate or better still rent out the entire house and move into a small apartment (or an RV or van or a tent if necessary) to give yourself more cash at the end of every mont to put to the problem.

Don't stress... many great stories start with a ton of debt (I know ours did)!  
You'll get there soon enough and look back at this debt and laugh at how big it seemed and how very far you've come!