Should I get out of debt before investing?
Columbus, OH · Member since 2020 · 8 posts · 34 votes
My wife and I are split 50/50 on wether or not to pay off all our existing debt such as student loans and auto payments before we take on more debt to invest into real estate, or we begin saving to buy our first rental property. My personal opinion is that debt in real estate isn’t true debt, but I am just curious as to what others have done and how others feel about this topic?
...or, you can invest and let the returns from the investments (cash flow/profit) pay off the debts...and then, you still have the investment income to do whatever you want with it. If you use your cash to pay off debt first, you have to generate those funds again to invest. If you invest first, you can let the investment returns fund the payoffs, and still have those returns coming after the debt is gone.
Quickly:
No debt- simple, more stress free.
Debt- not as simple, more stress.
@Zachary Giles I think your question is very much a personal one and you should certainly evaluate others' opinions knowing that there isn't a single right answer. As a non-recourse Fannie Mae and Freddie Mac lender in the multifamily space and as a lifelong investor myself, the way I look at is as follows: Capital costs money and it generates money. If the capital I would borrow will generate a higher return than it costs me (interest rate), that is a net positive calculation. For example, investing $50K in a rental property that will yield 8% versus paying off $50K in student debt which carries a rate (cost) of 6%. By the numbers, the net gain here is the 2% delta. In other words, the opportunity cost of paying off the student debt is 2% of the $50K.
As you can see, this calculation makes increasing sense as the delta grows. For example, if I am buying a car or a boat and I can finance $20K of the cost at 4%, I will do so (assuming I have the money to afford it with cash in the first place) if I can invest the capital into an investment that will yield me 10%, for example. Here, the delta that the capital is generating for me (and opportunity cost of not financing the vehicle) would be 6% of $20K.
So again, my calculus is that if the capital can generate a higher yield than the interest I would be saving by paying off my debts or not assuming them in the first place, then I say yes to the debt.
Of course, it is always important to factor in the risk of the expected yield. Taking an interest free loan to put the money into a savings account with a 2% interest rate would be pretty secure but running up a credit card at 16% interest to invest in a project that you hope will return you 25% may not be a good decision.
Also, as @Chris Pasternak (and probably others, long thread) noted, there are also intangibles such as peace of mind and flexibility that one could argue absorbs some opportunity cost.
The calculus also involves other assumptions such as:
- I have opportunities to invest capital - it does no good to pay interest on debt that you can't put to work
- There are things that I must buy (such as an education or an economy car to commute to work) - some things need to be paid for one way or another
- I will maintain reserves for living expenses - it is never a good idea to spend your last dollar, whether for an investment or for a purchase.
- Investing and growing long-term wealth is important and worth the headache of making such calculations
@Shiloh Lundahl had some great advice. @Zachary Giles you want to be a real estate investor you will always have debt. How you manage that debt will determine if you are successful or not. If you had $100K in positive cash flow a month you wouldn't care about the debt. Debt is not the issue. Cash flow and reserves are the concern. I read through all the posts and was surprised no one suggested to look at this from a banks stand point. First off, CASH IS KING. You pay off debt the cash is gone. Most people explained, what happens if something needs to be fixed, that is why you keep your cash and leverage what you can (that is why we buy real estate). This gets to the bank scenario. Your best rates are going to be with a broker or bank and get a conforming loan. They have lending rules (new ones) for a reason. Rule of thumb, front in debt is 30-35%. How much is the investment property payment going to cost you? I don't know your market and the more numbers we have the better advice you will get. Back in debt is 40-50%. This takes into account student loans, credit cards and car payments. The most disqualifying factor for borrowers are car payments and minimum payments on debt. a $300 car payment can be $60K worth of a home loan. If you have 2 cars that is a lot of house. If you qualify with the car payments than keep the cash! You can always pay off the cars and increase cash flow. The most important thing for you is to know your numbers. If you can find a value ad property, the return can be incredible. You can buy a duplex or small multi family that is mismanaged with under valued rents and have a huge return. Most new investors underestimate CAPEX expenses. How much life is left on the roof, water heater, carpets. $15k expense in 5 years is $250 a month in reserves for the next 60 months. Be sure you have the reserves or access to capital. Focus on consumer debt after you have the reserves you need for the properties in your portfolio. With that said, If you have a balance on a credit card at 25% it is hard to get ahead and see those returns. Get rid of it. Cars and student loans are low interest that you can do better in real estate with, if your ratios are good. They just take away from your borrowing power. Good luck!
It sounds as though you do not have a current mortgage payment. Depending on where you live, you can very easily house hack on what you currently have saved. A 3 - 5 % down payment on a 200k house should be easy to swing now or in a few months time if you are saving 2k a month.
Buy based on where you would like to have a rental someday. Move-in, keep saving and in 2 years, buy and move again. Get an agent now who is in touch with the rental market and get to know your market. The MLS is free to look at, just connect with an agent. Use BiggerPockets to track down a thread for your market and ask for agent recommendations.
All that being said, it can be a considerable burden on the family moving that often, but it is for sure the quickest way into real estate.
Good Luck
Danny McNulty
Financial Advisor
Let investments pay off your debt. It's a no brainer.
The world is all jacked up and inflation will skyrocket. Your only defense is something that goes with the times. Before you know it the debts you owe won't feel as big and your investment properties will have rents going up and fixed mortgage. Your cash flow will increase without you doing jack. Because you have debt, the one caveat is you don't get to enjoy any of the cash flow until you pay off your debts with it. What I'd do -- straight from Mike Michalowicz -- is set aside cash flow and use 90% to pay off debt. Use the remaining 10% to treat you (and your loved one) to whatever it can afford, a dinner, an ice cream, a coffee. When you pay off the debt, you get to do whatever you want with the cash flow.
Hi Zachary, in my opinion, the safest option is cash reserves so whatever your debt load is, you have a safety net. You can still invest in property and let a portion of the income from the property pay down your debt but at the very least have six months cash reserves in case of an emergency.
If the ROI on your investments is higher than your interest on debt, then invest away. Use the investment income to pay off debt.
Earning 15%+ ROI on an investment property is better than paying down student loan debt at 6%.
If you believe in real estate investing, then go for it. Don't let obstacles or doubt creep in.
@Ralph Chiaia
Totally agree! Married into massive student loans & going to ride crypto & silver as the dollar collapses & the debt becomes worthless!
@Zachary Giles
My wife and I are in the same spot as you, in some regard. I would definitely take the time listening or buying books above and I would like to add Dave Ramsey, "Total money makeover" to that list.
It all depends on comfortability with debt. We don't like debt either but like others have said it depends on the debt you want to take on. We look at rentals as assets as long as it provides a positive cash flow. After expenses and the mortgage is paid, if we make $20 - $400 profit we are happy. Hope it helps.