Pay Off Debt Vs. Investing

27 Replies

Hello BPers! I have a question regarding debt payoff vs. investing. I currently make a good income with my W2 position, own my home(owe about $178k on the loan), owe about 18k in student loans, and have just recently consolidated all my credit debt to a lower interest Prosper loan. I currently have about $10k left over from that loan and will be getting about a 4k bonus in the next week or so. My question is should I put all that money back on the loan and get it paid off quicker or take that money and find a way to invest the money. I am really interested in getting into real estate investing, but obviously don't have a lot of money at this point. Any advice would be helpful! Thanks!

I personally would take the 4K bonus and pay down the credit debt.


Just my opinion, but unless you can find an investment guaranteed to make you a higher percentage than your current loan rates, Prosper or student loans, it is better to pay down the debt, although I am not sure about that Prosper loan and if it has prepayment penalties, which would have to be considered.   And I would see it all as steps toward your real estate investing.  Make a plan going forward, like after the bonus payment, pay x amount more than you do now towards your debt each month, and see it as a step closer to the goal with each payment.  I've found that if you see it all as working towards your goal then you do feel like you are moving forward instead of just digging out of debt, and it makes a huge difference.  

I have been consumer-debt free for 3 years and it is fantastic.  I had 14 credit cards at one point early in my investing.  I would use credit card checks for down payments on seller-carry's.  I was paying a little extra here, a little extra there and was frustrated.

Focused intensity will get rid of the cards and the student loans.  Wanting to invest, but waiting until you pay off the other junk will motivate you more.  I highly recommend paying off those debts first @Benjamin Reemsnyder !  It's amazing how much builds up when you're not sending all your money to someone else!  

Thanks for the replies! I kind of figured that paying off debt was the way I should go, but I want to get into investing so bad! I want to go about it intelligently however and know that real estate will still be here in a year or two that it would take to pay off these debts. I listen to the podcasts and it is nice to hear that for some of the most successful investors it took 5 years to purchase their first property, so it gives me time to get a firm understanding of the basics and get the h&#$ out of consumer debt once and for all.

I've been in the same boat, I'd recommend this order. 1) CC debt, 2) house hack (if possible, buy a duplex or triplex, live in one unit and rent the others out and it should cover the whole mortgage so you live for free, saving you like, $800 a month on rent which is the best return you can ever get. 3) student loan debt. 4) investment properties using the BRRR strategy. You can take the same $40-$50k and reuse it over and over to build a portfolio without having to save up for a 20% down payment over and over. And $4k isn't nearly enough to start real estate investing. ALSO, always keep a $10k emergency fund, if you get in a bad car accident or get fired or laid off, you'll be glad I told you this, and you NEVER know when that can happen, both have happened to me and my sister.

@Benjamin Reemsnyder

I agree that paying down your credit card debt is the way to go.  Once you get your credit card debt to zero.  Then you can start focusing on investing.

Like the others have stated, I would focus on paying down your debt. In the meantime, take the time to learn more about investing and the market in which you look to start investing in. Once you pay off some/all of your debt you'll have more "free" money which you will be able to put towards REI.

In my brain, I knew that paying off credit debts, student loans, etc. was the way to go because the amount of cash I have is not enough to really do anything in the investing world. I have that beginner desire to want to jump right in but want to be smart about it, so my thought process is to really focus on paying off the loans and in the meantime learn the most I can about real estate investing and find a mentor to work for on the side and learn from in the meantime.

Another option would be pay minimum on your bad debt now.  Save up for a down payment plus reserve.  Then attack your bad debt with the cashflow from your investment.

1. Reserve Fund
2. Invest
3. Payoff Bad Debt

I would agree on paying off the debt first, then build up a nest egg and then start thinking about investing in real estate.  Years ago I had a wise loan officer tell me, "don't become real estate poor".  I have remembered those words of wisdom during my investment years.  You have to have extra cash available so when a hot water heater goes out or the air conditioning just shot craps or...

Can't put a price on how it feels to be debt free.  My wife and I are there other than our primary residence that is at around ~60% ltv.   Other than a huge tax bill I have to deal with this next April all of our extra income is allocated towards investing (real estate and stock market).  You can really accumulate a pile of cash quickly when you get to keep most of what you bring in.

Adding to the chorus above, I would recommend getting that consumer loan out of the way before you start your RE investing career.  The cheapest debt you'll find for beginning investment property purchases are standard 15 and 30 year mortgages at <5%, and you stand the best chance of getting those rates with a clean credit report with low/no consumer debt. 

You'll also sleep better after buying your first rental property knowing you've got an emergency fund that can handle emergency property repairs, or can cover the mortgage and taxes while you evict the deadbeat tenant that sweet-talked you into renting to him and never paid a dime

@Benjamin Reemsnyder

Do you have enough equity in your home to access a HELOC? If so, you could potentially reduce your monthly interest expense, allowing you to pay off your principal credit card/Prosper borrowings faster. For example, I have a lot of grad school loans as high as 6.8% but have a HELOC with a promotional rate of 2.99% (fixed for one year, then floating). That's a pretty large spread that you may be able to take advantage of.

What if you did a combination? You could set aside x money to pay down debt and x to go toward a downpayment/repairs/whatever else on your first rental property? My husband and I did a combination of this a while back. We accumulated a bit of credit card debt (not much, maybe $8K) and we would pay $500 extra a month on that debt and put $500 towards investments. I will say that the $8K was moved to a interest free credit card for 18 months, so we didn't have to worry about interest. But that way we were paying down debt AND moving forward with some investing. Just an idea :) Best of luck to you!

I did try to get a HELOC on my primary residence but was turned down because of my debt to income ratio was about 1% too high and they said that the LTV was not less than 80%. I have also considered doing a cash out re-finance on the home, but am not sure yet. I owe 178k on the mortgage and the preliminary appraisal that Wells Fargo gave me when I applied for the HELOC was $230k based off what the comps are selling for in my market. The original loan about was 185k and I read online, don't believe everything you read online, that they base the LTV ratio on the original loan amount for the HELOC, not the appraisal value. Is this true? Any insight?

Originally posted by @Benjamin Reemsnyder :

In my brain, I knew that paying off credit debts, student loans, etc. was the way to go because the amount of cash I have is not enough to really do anything in the investing world. I have that beginner desire to want to jump right in but want to be smart about it, so my thought process is to really focus on paying off the loans and in the meantime learn the most I can about real estate investing and find a mentor to work for on the side and learn from in the meantime.

I was in a similar situation and paying down debt has worked well for me. My wife and I had over 125k in student loans when we starting worked, no credit card debit. We've taken our student loans down to 30k (10k of that is at 2% which I will NOT be paying off earily... that's almost free money). Now that we have almost all of the highest interest (4-6%) student loans payed off, we are expecting to have a LOT of "extra" income and are planning to buy rentals with that.

So I would follow the highest interest loans you have and then once the higher ones are payed off you can look into investing with the extra money you would have been paying on those.

In the same boat,  decided to pay down all credit card debt and portions of school loans first then I'll invest. 

I agree with Tom Smith on this one and it looks like I am in the minority. I was in the same boat you are in and if I could do it over I would invest as early as possible for a few reasons. 1. Your newly created cash flow will help pay down your debt and you will still have it after you pay it off. If you pay off your loans you will have no cash left nor have any cash flow vehicles. 2. Investing first forces you to learn more about real estate investing. You will learn more with skin in the game which will get you where you want to be quicker. 3. Lastly in my case when I payed something off I as always tempted to spend on credit again. I know 4k isn't much to start with but save it and before you know it you might have another small windfall of cash ( tax refund, ect)

The beauty is that you don't have to choose.  You can have it all if you learn to invest properly.  

Your options are more limited if you chase after the no money, no credit projects.  They do exist though.  Learn to purchase properties subject-to and keep adequate cash reserves to service capex issues.  Purchase the right properties and you'll have built-in equity using someone else's credit.  Make sure you disclose that the loan can be called and you don't have the ability to pay it off if the lender does so.  This is the ethical thing to do and is how you'd want to be treated if you were the seller.  

Then you can prepay your debt aggressively without shelling out every last cent toward paying the debt down.  Liquidity equals staying power and you don't want to give up every spare bit of it in pursuit of a quicker debt payoff IMO.  Save some of the cash as buffer dough for your new investments purchased (ethically!) subject-to and use the excess to pay down your debt quicker than normal.  

Your focus should be on generating free cash flow in some way.  Learn to reduce your expenses.  Reducing your expenses is a quicker and more tax-advantaged way to increase your savings rate and give you the fuel needed to invest and pay down debt.  Force yourself to reduce your expenses by an amount equivalent to what you would have paid your debt down with the free cash you got over some short time period; say....a year.  

Keep in mind that if you buy right you'll be benefiting from all 4 areas of wealth generation through rentals:

1.  Appreciation

2.  Depreciation

3.  Tax shields

4.  Amortization of the loan

From a strictly mathematical point of view it is better to invest as early as possible to take advantage of all of this while maintaining your resolve to eliminate your debts quickly.  

Paying down debt IS investing. If you pay off a credit card that charges 18% Interest then it is the same to your net worth as investing at 18%

A factor I didn't see mentioned is what kind of cash reserves do you have? If using all that money to pay down debt leaves you with no cash reserves then you are at risk of a small problem becoming a very big problem. Most financial advisers say you should have about 6 months of your income in cash reserves.

it wont hurt if you take a chance..i would...

@Benjamin Reemsnyder , here is my 2 cents.  First get a handle on your financial situation.  Set budgets and plan how much you will save for investing and how much you will pay down on bills.  You do need reserves, get some set aside.  Next pay down on the credit card loan.  While you save up money start reading through the Learn section and get educated about the business.  Start looking hard at your market prices and locations so you will know a deal when you see one.  Getting your debt down will help you get financing.  Us the time wisely by getting educated and learning your market.  When you have money saved up you should be in good shape.

As stated above, depending on your equity position in your current house and rates... why don't you take a HELOC out and pay off the prosper and student loans? The LOWEST prosper loan is in the %7's. I know my student loans were 6.55 until I refinanced them through SOFI at 3.22 (highly recommended). I invest in lending club on the side for the last 3 years and it has helped me (along with the stock market) be able to invest at an earlier age.

I can share my own story with you.  in 2012, I was $60k in debt.  I had just switched jobs from being a salaried employee to a commission only salesperson.  

I received my first big commission check which was approx $45k net.  I struggled with whether to pay off most of the debt or do my first real house hack.  I opted for the house hack.  

I was able to get a FHA 203k loan because it had been 7 years since I owned a home. I was able to purchase a $339k 4-plex with $40k in renovation funding for about $13k down payment. The rent on the other 3 units paid my whole mortgage plus my utilities and cable/internet bill. I put about $30k in additional improvements/repairs into the property.

I lived there for about a year and a half and then did another house hack.  This time with conventional renovation financing with 5% down.  I turned that first 4-plex into a vacation rental, and this year I'll net about $65k on that property.  I consider my P&I an expense, so that number is true net cash in my pocket.

In my new place, rent pays mortgage, utilities, etc.  So I'm living rent free and now have an additional $65k annual income stream that I wouldn't have had if I had paid down part of my debt instead of investing in real estate.  

My debt is about $17k now. I'm not super worried about paying it off. The interest rate on my debt is only about 4.5%, and I know I can beat that by a mile with investing. Other positive effects of choosing this path - my credit score jumped from 650 to over 800 and my net worth is close to $1m (totally on paper, at least for now!). Because I look good on paper, I have access to so many options that I never had before. I have a $100k HELOC that I got so I can tap into it to purchase other properties for cash, for example.

In my experience, if you have an idea for making money from your cash or if you have an innate level of entrepreneurial hustle flowing through your veins, you can handily beat the return on debt pay down.  If your idea of investing is more along the lines of just dumping your $4k in a Vanguard index fund, you are probably better off paying off your debt and reducing your monthly payments.

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