Paying off Student Loan vs. REI

14 Replies

Hello guys. I know this question has been asked many times before, but since every situation is different, I want to hear your feedback on my situation. 

I currently have $30k student debt. I have a very stable job with consistent income. Recently, I got enough money saved to cover this debt.  However, I am thinking about investing in a duplex instead of paying off my student debt. My reason is following:

I am currently living in an apartment, which I pay $600 a month on a rent. If I buy a duplex that costs around $150k, I have enough money to put down 20% down payment (and yes I am considering extra cost such as closing fee, inspection fee, etc). My student debt has 4% interest rate, and according to my calculation, I would have to pay about $6500 for interest in the end (in 10 year duration).  Now since i am paying $600 a month on rent, if i buy a duplex, it will go toward mortgage instead of giving away to someone else. So in theory, I am saving $600 a month on rent and putting it toward my asset. And since I am planning to buy a duplex, I will be renting 2 out 3 rooms to tenants, which will generate cash flow. So base on my crude math, I will be making $200-300 a month from tenant after taking care of extra cost. 

I personally feel like this sounds too good to be true. Yes, I do have an option to pay off my debt. But if I risk a little bit, it would benefit me tremendously in a long term according to my calculation. Did I miss something here? Did I forget to include in my decision (beside the fact that bad tenants can be a nightmare)? What do you guys think?

What is your risk tolerance? My husband has a very stable job. We have no children and a high lol seance for debt. We also know the market and interest rates are changing. The interest rates and prices are increasing . Therefore we are trying to get to 10 house by next march. Therefore we are assuming consumer dept and moving money around to let us achieve this goal. can this is not for everyone but I am comfortable with it. My undergraduate was a Fiannce degree with a MBA. So it's also my field.

We got atarted with personals. I would agree with the situation but truly comes down to comfort and risk

Elizabeth Colegrove Thank you for your reply. Lol no worry about being personal. After all, we are in personal finance forum. I mean I know I am going to make mistakes on my first REI, but I am trying to minimize damage by researching and understanding the art of REI. I understand that the property may depreciate instead of break even with 3% annual inflation, so I might lose money in a long term, but that's risk I am willing to take. I am just curious if anyone in here sees any noticeable flaws in my plan. Also I still have sometime before i put my plan into action, so I do have time to reconsider if my plan seems flawed.

Most properties I buy need some rehab before I rent out.  I would reserve funds for that.  I would also reserve 3 months of expenses of the duplex.  At 5% interest the mortgage is about $644 per month plus other expenses per month.

Since you are living in one-half of the duplex it will  probably break even before the mortgage payment.  Unless the duplex is a great deal I would probably not go ahead.

Just my opinion.

Bill

I think you have found a great solution.  While it is a risk and you will have to plan for maintenance, repairs, vacancies, etc., versus set fee for rental, you are actually creating a somewhat passive income to pay off that debt (always smart), building equity in a growth market like Raleigh, and building a real estate portfolio instead of paying to build someone else's.   Read all you can on tenant screening here on BP, as that will alleviate a lot of the bad tenant risk.  Best of luck to you.    

@Roy C.  This a a great question and one that I don't think has a "right" answer. I've contemplated this myself and have analyzed the numbers. For me, I decided to invest in real estate rather than pay off my student loans. I figure my student loans are between 5-6%, but I can make much better returns than that on a rental property. I can use that extra income to help pay off the student loans, and then once they are paid off I'll still have an asset to keep producing income. Good luck!

Originally posted by @Rodney Kuhl :

@Roy C.  This a a great question and one that I don't think has a "right" answer. I've contemplated this myself and have analyzed the numbers. For me, I decided to invest in real estate rather than pay off my student loans. I figure my student loans are between 5-6%, but I can make much better returns than that on a rental property. I can use that extra income to help pay off the student loans, and then once they are paid off I'll still have an asset to keep producing income. Good luck!

 Rodney,

That's 5-6% paid with after-tax dollars.  When you factor in your marginal tax rate, you are looking at an opportunity cost of 8-12+%.   

@Roy N.  Can you explain your math for me? I'm usually good with numbers but not putting those numbers together quickly in my head.

Originally posted by @Rodney Kuhl :

@Roy N. Can you explain your math for me? I'm usually good with numbers but not putting those numbers together quickly in my head.

 Your student loans are paid from after tax money - monies in your pocket after your income taxes are paid.  

As a simple example for illustration purposes: If you are in a 30% tax bracket, then every dollar diverted from paying down your student loan would need to return $1.30  (your opportunity cost) to break even.  Hence if your student loans are at an interest rate of 6%, your investment would need to return >=7.8% (Cash-flow-before-taxes) to break even.  A return less than that and you would be better off using the funds to pay down your debt.

@Roy N.  Right, so if I am able to make 15-20% return on a buy and hold investment, then I'm better off investing than paying down the student loans, which is what I'm doing.

Thank you very much for your input guys. That was very helpful!

Originally posted by @Roy N. :
Originally posted by @Rodney Kuhl:

@Roy C.  This a a great question and one that I don't think has a "right" answer. I've contemplated this myself and have analyzed the numbers. For me, I decided to invest in real estate rather than pay off my student loans. I figure my student loans are between 5-6%, but I can make much better returns than that on a rental property. I can use that extra income to help pay off the student loans, and then once they are paid off I'll still have an asset to keep producing income. Good luck!

 Rodney,

That's 5-6% paid with after-tax dollars.  When you factor in your marginal tax rate, you are looking at an opportunity cost of 8-12+%.   

 Thanks Roy. I know this is an old thread, but this is a great way of thinking about student loan %. I'm in a similar situation and hadn't considered it this way.

Roy,

I am no professional here, but I think you have the right idea.  The objective is to increase your income without increasing your expenses.  If you can do that then go for it.  You must take into account whether you are better off using all the money saved for the down payment or whether you could qualify a first time homebuyers loan with a 3.5% down payment.  Use a little extra to pay some points to qualify for lower interest.  Have some money for the repairs and use the rest to pay down your student loans, providing they do not have an early payment penalty.  The less money you put out of pocket on your property, the higher your cash on cash return on investment will be.  Just make sure your mortgage payments are lower than what you can get for rent when it is fully rented.  You don't want to move out and not be able to rent your unit for the $600 you were paying for rent.  While your property may not appreciate, neither will your  loan payments.  If you are looking for a long term investment and you are good at figuring out what a good deal looks like, I think you most certainly have a good plan.  

This is modified from an answer I gave to another post but it's related so...

This is a tough question, and extremely valid.  I have a Masters degree and the school loans that came along with it. Mine total about the same as yours. I have operated from the philosophy of "I want it all" ... meaning I try to both invest in RE and pay down my loan. I haven't put off investing just because I have student loans to pay. In reality it may be quite a while before those are paid off. So what I myself have done is work, make as much money as I can with my full time employment, live modestly, buy and live in the property, rehab a little if necessary, save until I can buy another, move into that one and rent out the last. Rinse and repeat. All while paying at least $50 monthly more than the minimum on the student loan. Throw as much as you can at that. I am currently living in one of my duplexes. I hate the idea of paying rent to someone else. I'd much rather pay off my own property.  

I'm not any super credible source but this method has worked for me. I think if you are really passionate about buy and hold investing (and are ok with the managing aspect) and you're willing to put your all in it while maintaining full time employment (assuming), you can be moderately to very successful. And the bonus is that any added income can help chip away at that loan. At the very least you are not throwing rent at someone else, helping them get rich. I also follow Dave Ramsey, though he would kill me for mentioning his name with the advice I just gave you.

I say just go for it but be smart. Good Luck!

Buy the Duplex all the way. (as long as it is a cash flowing property from day 1)

I subscribe to the "rich dad, poor dad" view of debt.

Good debt = rich dad is debt that allows you to acquire cash flow producing assets (rental property) with appreciation as icing on the cake

Bad debt = poor dad is debt that produces no cash flow and no appreciation (cars, fancy dinners, etc..)  

student loan is neutral debt because it does not produce cash flow but the loan helped you to get a college degree which then helped you to get a job.

Don't forget inflation which eats away at your loan (mortgage or otherwise) when the rate is low 4-5%  (inflation around 3-6% traditionally).   100 dollars now will be worth 90 dollars in 5-10 years.  so borrowing at a low rate now is a good thing if you are buy cash flowing properties.

One more thing, make sure to have reserves so that you can cover unexpected costs when buying/holding real estate.   reserves can be in cash but also HELOCs, even credit cards (if you use them wisely)

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