Beginner investing: Pay off student loans or buy property?

Question

am 28yrs old in LA working in marketing.

Right now I have about $20k in a high yield online savings and money market, and not exactly sure which I should focus on more - paying off student loans, saving to buy a house, or buy a smaller property like a condo now while interest rates are low.

So far I have been following a PIP plan:

P - Preparing for the unexpected by having an emergency fund 3-4 months of worth of living expenses (part of my $20k) and the proper insurance

I - Investing for the future by contributing 6% of my salary to 401k Roth after-tax (however unfortunately with no match)

P - And my only debt to pay off is my low interest rate student loans ($35k at 6.08% interest rate). I have no other debt! At the current rate I am paying it off I will be done in about 7-8 years (and I am also looking into refinancing for a better deal to find possible better options).

I also have a good high credit score so I want to take that to my advantage as well. I want to invest more in my future but I don't know which way to focus:

1. Paying off student loans more aggressively, most of my savings

2. Invest in a more diverse portfolio like Betterment, Wealthfront, or RealtyShares

3. Save more for a house and still pay my student loans but at a lower amount

4. OR take advantage the historic low interest housing rates and purchase a small condo before they rise (which will be around the election). As of now after my emergency fund, I have about 3-4% down of $450k (another part of my $20k), which I know is not ideal but I would want to take advantage of the low interest rates, plus I would be living with my boyfriend and brother who would be helping me pay it off/splitting it 3 ways.

If I do go this route and purchase something in 6 months which would the most cost effective way:

- Get a FHA with as little as 3.5% down, however it would hurt me that I could never cancel mortgage insurance, however at least it would be a tax-deductible expense when you itemize deductions on Schedule A.

- A conventional loan (also tax deductible) and try to take advantage of being able to cancel it with Automatic termination when my mortgage balance reaches 78% of the original value of the property (no appraisal) or Final termination when I reach the midpoint of my loan when it's interest-only product, have a balloon payment, or were given forbearance by my lender.

- Or avoid mortgage insurance altogether while putting no money down by utilizing a combo loan. If you keep I first loan at 80% LTV or less, and add a second loan of 20% or less, I can still obtain 100% financing without paying PMI. Along with that, I'll most likely snag a lower blended mortgage rate by splitting the loan up.

- I can look into the Bank of America No Fee Mortgage, a so-called no cost loan that doesn’t require mortgage insurance, presumably even if the loan exceeds 80% loan-to-value. The TD Right Step mortgage also allows a three percent down payment with no mortgage insurance required. However, these programs typically have the mortgage insurance built into the interest rate, so it’s not really free. Most homeowners these day opt for a second mortgage instead of doing one loan to avoid high interest rates and private mortgage insurance. The only real downside is the associated fees with a second mortgage, and the two separate payments.

So there are options to make it work if jumping on real estate is the best way to use my savings. Also, since I would be a first time home buyer I would work all the bells and whistles that come with it - including no closing costs. So I do not plan on paying that at all (I know of a lender that has done this for other family members who were firs time buyers). So should I get pre-approved now just to see where I stand so I can have a more realistic idea or no since it effects my credit?

I want to invest more in my future and I think now is a great opportunity for this since interest rates are the lowest it has been, but I'm not sure if jumping into real estate now is the way to go - or pay off student loans aggressively and get them out of the way or keep saving or invest in other systems. Looking for some serious direction.

Thanks again,

Ally

Thomas S. · Answer

I personally prefer that young investors pay off all bad debt before they get into good debt.

Secondly if you buy a property never ever ever rent to family, boy friends or any friends in general.

Watch any 1/2 hr. episode of Judge Judy and you will find out why. Don't think it will happen to you, guess again.

Frank Jiang · Answer

Hey Gino,

Respectfully disagree. Ramsey's target market is typically people with little or no financial savvy. He gives great advice to people who have multiple debt sources and need to learn the fundamentals to simply get out.

I don't believe Ally falls under this category because from her post we can infer that she:

- Has savings

- Creates positive net income every month

- Has no other debt besides student loans

If the OP plans to buy a house at some point in her life, there is no better time to do it than now. What's the point in spending extra time to pay off a 6% student loan debt, spend more time saving up for a down payment, only to find that in the meantime, interest rates have risen to 7%?

Frank Jiang · Answer

First, don't contribute part of your salary to 401k ROTH. If there's no match, there's no point. If you would like to contribute to your retirement, you can open a separate ROTH IRA and manage it yourself. You will get much more flexibility in your investment options and your money will be more liquid compared to the employment restrictions of the 401k.

In a similar vein, I would not consider investing my money in a diverse portfolio. Focusing on diversification and smart investment is something that becomes more important once you've already built up a nest egg and it's less relevant when you're relatively new out of school and still building your wealth.

You'll hear a lot of people say stuff like "oh you can invest that money in the market and make more than 6% and you can pay the student loans with the difference." This is actually really bad advice. If you're familiar with CAPM: say the stock market returns on average 8% annually and let's guess that 1% of that is the risk free rate and 7% is your market risk premium. You however, have a risk free rate of 6% by paying down debt. If you were to invest money in the market, you would be taking on 7% risk premium to only gain an additional 2% over your risk free rate. Totally not worth it.

I agree with you that interest rates are at historic lows and it's a great time to lever up if you can. However, you're pretty tight in terms of savings even with a 3.5% FHA loan. If you can get a no closing cost loan (in reality rolled into the mortgage), that'd be ideal. How would boyfriend/brother be contributing? Will they contribute to the down payment? Will they be on title? Will you be the sole proprietor and basically just have them be tenants?

Charles Moore · Answer

you've got a cheap fixed rate on your student loans at 6.08%. And like you've mentioned, mortgage rates are even lower today as opposed to the future. If you use your cash now to pay off your student loans, you'll be left with no option later except to use more expensive mortgage rates. Might be better to keep your cheap student loans now AND get a cheap mortgage at the same time.

First things first, though - you might want to get prequalified now. Mortgage lenders don't really hurt your credit score when they run it, unlike credit cards and auto loans and everything else (because mortgages are considered good debt vs bad debt for everything else). You can then get prequalified again in 6 months if you need to; a mortgage lender credit check only affects things for 3 months after it runs, so your time frame would allow for this.

Next, what are the condo HOA dues? You'll have to add that into figuring the three-way split with your brother and boyfriend.

Also, any special assessments on the horizon you'll have to pay?

If you're set on a condo, I might opt for either the 3.5% FHA loan or the other low-money down options, if you three can afford the payments. That way, you can preserve more of your capital and invest it elsewhere, like a downpayment in an out-of-state property offered by a turnkey company in Memphis or Dallas or Kansas City or Cleveland or Birmingham, to name a few.

After you live in your condo for 2 years, you could sell it to take advantage of the appreciation, and take the profit tax free to put into more properties, including another primary residence.

JD Martin · Answer

Based on where you live, your best return is probably to pay off your student loans. Unless you want to be an out-of-town investor.

Account Closed · Answer

I think it's clear when you say you are contributing 6% of your salary (with the assumption you are making less than 100k post-tax), that you are contributing around or less than the max annual Roth IRA (5.5k) contribution to your Roth 401k. So it does make sense to contribute to a Roth IRA instead.

But for the sake of others reading this thread, a Roth 401k can be have a significant advantage over a Roth IRA just in the contribution limit - $18k vs $5.5k annually. So while an IRA does offer you more freedom with investment choices, if you ever want to contribute more than $5.5k you'll need to go back to the Roth 401k. The 401k also doesn't have an income limit, which is a big disadvantage for the IRA. So if you are planning on making $132k+ a year, you will be completely ineligible to contribute to the Roth IRA.

When you leave your job you can always roll over the Roth 401k to your Roth IRA penalty and tax-free.

So in short, if you are planning on contributing more than $5.5k a year to retirement accounts or if you expect to make $132k+ a year in the near future, you shouldn't discount the Roth 401k just yet. If there's no penalty to keep it open and no minimum contribution then you might as well.

Steve Endress · Answer

@Ally Garcia If you don't start with at least 100K, I don't think it makes sense to be a passive RE investor. People starting with little/no cash either are making a full-time job of it or are borrowing at high rates.

Christos Anastasopoulos · Answer

Great Work! Check out "SoFi" if you haven't already. Mike Cagney and his group are doing great things with student loans, it's worth looking into... And otherwise keep doing what you're doing, eventually you can can roll your 401k into a self directed 401 or IRA account that you can then move into real estate as you feel ready.

Charles Moore · Answer

Also, I ordinarily steer clear of condos and prefer single family homes, mostly because condos don't appreciate as fast as SFHs (in most markets) and the HOA can range from being annoying to just downright getting in the way of your real estate plans, plus they can force you to pay assessments for upgrades and repairs to the whole building that run in the thousands of $.

However, your market may be different because of crazy CA appreciation, and how young folks just starting out can only afford condos as their first primary residence purchase, leaving you with little choice if you want to dive in today to take advantage of low interest rates and expected appreciation.

Charles Moore · Answer

Hi, Ally. Sorry, I wasn't clear. I recommend just stop contributing to your company's non-matching 401k. As an extension of that, you can actually roll your current Roth 401k into a Roth IRA at no cost and without tax penalty, then contribute your $5500 max per year to the IRA. You'll have greater control of your account that way anyway. Some of the best IRA companies out there are Vanguard - the original leader in low cost index funds or ETFs which beat out actively managed funds over the long term - followed by Charles Schwab. Most other companies piggyback on the funds those companies created, and charge you their middleman fee, reducing your returns. At Vanguard, you can invest your funds in a basic portfolio of VTI: Total US stocks (basically a sampling of all US company stocks), VXUS: Total international stocks (a sampling of all stocks from the rest of the world), and BND: Total US bonds. I personally like to throw in some specialized VNQ: Vanguard REIT (real estate investment trust) ETF because it includes rental income in the form of dividends from various sectors of real estate like hospitals, apartment complexes, storage facilities, office buildings, and retail shopping centers - areas I would not invest in yet personally, but instead through a REIT, which typically has higher dividend payouts than other funds. Direct providers like Vanguard don't charge you mandatory fees to maintain your account like middlemen companies do; instead they provide their funds at cost, only taking a bit from the dividends (called expense ratio) before the dividends reach your account. Anything with an expenses ratio below 1% is great from a cost perspective, and Vanguard's start from .05%.

Regarding Realty Shares, that company only allows accredited/sophisticated investors to invest; aka, rich people with over $1 million in net worth excluding their primary home or over $200K annual income. As for Betterment and Wealthfront, I don't know what their fees are or what funds they offer, but if they require you to pick individual stocks or charge middleman fees, avoid them. Just go straight to the source like Vanguard or Charles Schwab.

Regarding your loan type, I think based on what Frank said, an FHA loan sounds attractive, if the payments with HOA dues are manageable for you. That would mean keeping more of your initial capital for other investments simultaneously, and since PMI bothers you, just think of it like this: the rent from your brother and boyfriend go to pay the PMI, insurance, and HOA dues, while your portion pays principal, interest (tax deductible), and taxes (Also helps on your federal return), or some mix like that. The idea is to put as little of your own money into this asset, and as much of other people's money (OPM) as possible, then reap rewards later.

Then sell after at least 2 years and reap tax-free profit from your expected appreciation to buy another primary and maybe another investment property.

Beginner investing: Pay off student loans or buy property?

Beginner investing: Pay off student loans or buy property?

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