Pay off debt or invest (age old question)

OP

Member since 2020 · 104 posts · 36 votes

6y

Thank you so much for your reply Brenden. I'm sorry if I came off as looking for validation. That is certainly not the case at all! I was just hoping to convey that I am not afraid to let that debt remain if that is the best plan, since I can easily afford the payments.

I read the newbie guide, as well as a few other articles, and have a general idea at this point of how to evaluate properties... I think. The trouble I'm running into is, at least in my area, there do not seem to be many properties which are at a price point to generate cash flow and cash on cash returns which exceed what I could likely achieve from stocks or private lending. I'm guessing I'm probably doing something wrong in my calculations. I'll start posting in another section about some scenarios I'm finding and see if anyone can help me get a feel for running the numbers.

As for the 2K number... That's about what my core monthly expenses can be indefinitely, so I would like to at least have the comfort of knowing my expenses will always be covered, even if I was unemployed for a period of time. At that point, I could also start considering going into business for myself. Ideally I'd want a bit more coming in, but I wanted to be as realistic as possible to start with.

Robert TinkerPro Member

Rental Property Investor · Round Rock, TX · Member since 2019 · 251 posts · 159 votes

6y

@Phillip Rosin Pay off the $65k. Then you would have $550 more each month, guaranteed. Your debt to income ratio is now better allowing you to qualify for loans for your investing easier.

6 Reply

Robert TinkerPro Member

Rental Property Investor · Round Rock, TX · Member since 2019 · 251 posts · 159 votes

6y

@Phillip Rosin Good debt is one that earns you a return. Bad debt won't earn a return.

3 Reply

OP

Member since 2020 · 104 posts · 36 votes

6y

@Robert Tinker Thank you for your input. I certainly agree that any debt that doesn't earn a return is not desirable and I am equally considering paying off my current debt.

If I pay off my debt, leaving around 40K left, would you suggest I then wait and save up for a year or two, to get a larger down payment available, or try to find a lower priced property and start from there? Also, would something in the middle also work, like paying off the car loan, which would free up $300 each month?

Regarding debt to income, I'm currently sitting at roughly 20%. Paying off the car loan would put me around 15%. Is under 43% generally still the guideline? If I paid off my car loan, for example, I'd be under 43% with an $1,800 mortgage for a full rental. If I got something I could live in, my current rent expense of $750/month would no longer be in play, putting my DTI even lower, since we'd rent out my girlfriend's place and she'd pay rent and live with me. Just bouncing around numbers, since I can't keep them out of my head lol.

Robert TinkerPro Member

Rental Property Investor · Round Rock, TX · Member since 2019 · 251 posts · 159 votes

6y

@Phillip Rosin, Lots of different directions you could go. I went the direction of an inexpensive rental that I Brrrr'd. I felt I had less risk with a low price property if everything went South. So far so good. You could save up more and go for a higher price dwelling. You could house hack and have a low down payment as an owner occupy and rent rooms out to cover your mortgage and save even more. Good luck with your endeavors. Just do the math.

Mark S.Pro Member

Rental Property Investor · KY · Member since 2013 · 1k+ posts · 538 votes

6y

@Phillip Rosin, lots of options.

If you want to start with a completely clean debt slate, then maybe you pay off all the debt, are forced to save a little bit more first for REI, and then jump in.

If you want to go the semi debt pay down route, you then have a choice:

The car loan is smaller, has a higher interest rate, and larger payment. One could argue to pay this off first (your auto loan interest rate seems very high for someone with excellent credit). This would free up (slightly) more monthly cash and would (slightly) help your DTI, although DTI help here vs student loan payoff is negligible.

The student loan is with you forever regardless, so one could make an argument for paying that off first even though the monthly payment is less, interest rate is less (are you able to deduct your student loan interest in your particular situation - if so, your effective interest rate is even less!), etc.

If you want to maximize every dollar that you have, can keep your expenses low like you mentioned, and want your money to start working for you as efficiently as possible, maybe you just continue to make the payments and carry the debt while simultaneously investing in real estate

At the end of the day, you need to do what makes you comfortable and allows you to sleep at night

OP

Member since 2020 · 104 posts · 36 votes

6y

@Mark S. Thank you for your input. Ideally yes, my goal is to maximize every dollar, so long as the gain is outweighs the cost enough to make it worth the effort. The car loan was on a used vehicle from a dealership and I stupidly hadn't shopped ahead for a loan. I figured I'd quickly pay it off or refinance. It's only been a few months. I paid half cash, half financed. Credit score is well over 800 at the moment. With regard to REI, I'm eager to get the ball rolling, but cautious about making a poor investment, of course. I watched the newbie webinar and will be analyzing several properties a day for a little while. I still need to speak with a loan officer to see what I qualify for. Any suggestions on specific entities to contact as I shop around? Thank you!

Ola Dantis

Multifamily Syndicator · Houston, TX · Member since 2016 · 1k+ posts · 2k+ votes

6y

@Phillip Rosin Hey Phillip,

I'd suggest you come up with a hybrid strategy in which you are paying off consumer debt gradually, so more than you are paying today now and start investing in Real Estate alongside.

Consumer debt, in my opinion, is the worst.

OP

Member since 2020 · 104 posts · 36 votes

6y

@Ola Dantis Thank you for your input. I am in a lucky position that, after my core monthly expenses are deducted, I have roughly $2,500 dollars left over each month from my regular income take-home. On a side note, with my company match, I currently have 10.5% of my base income going to a 401K. One idea was to pay off my $9,500 car loan, to which I pay 300 a month, and put that monthly payment toward my student loans. That would more than double my current payment, and then I could start making even larger payments, as well as save for more REI deals, as time goes on.

Also, my student loan interest is tax deductible, as far as i know.

Mark S.Pro Member

Rental Property Investor · KY · Member since 2013 · 1k+ posts · 538 votes

6y

Originally posted by @Phillip Rosin:

@Mark S. Thank you for your input. Ideally yes, my goal is to maximize every dollar, so long as the gain is outweighs the cost enough to make it worth the effort. The car loan was on a used vehicle from a dealership and I stupidly hadn't shopped ahead for a loan. I figured I'd quickly pay it off or refinance. It's only been a few months. I paid half cash, half financed. Credit score is well over 800 at the moment. With regard to REI, I'm eager to get the ball rolling, but cautious about making a poor investment, of course. I watched the newbie webinar and will be analyzing several properties a day for a little while. I still need to speak with a loan officer to see what I qualify for. Any suggestions on specific entities to contact as I shop around? Thank you!

I would probably pay the car loan off, take the monthly savings and plow into student loan, take the cash you have and get in REI. I buy turnkey, so my strategy is a lot different than many on here.

Steve Vaughan

Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes

6y

A risk-free, hassle-free COC return of 10%+ ($550/mo on $65k] is an investment I would argue. No tenants or taxes. Pay off the debt.

Something changes in your spirit when you don't have a car payment. It's more than the interest rate.

4 Reply

Bryan Hancock

Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes

6y

I didn't read everything about your personal situation, but for all readers here is the general order, which is bandied about on the MMM forums and Bogleheads quite a bit:

WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the current 10-year Treasury note yield.
3. Max Health Savings Account (HSA) if eligible.
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if
- 401k fees are lower than available in an IRA, or
- you need the 401k deduction to be eligible for (and desire) a tIRA deduction, or
- your earn too much for an IRA deduction and prefer traditional to Roth, then
swap #4 and #5)
6. Fund a mega backdoor Roth if applicable.
7. Pay off any debts with interest rates ~3% or more above the current 10-year Treasury note yield.
8. Invest in a taxable account and/or fund a 529 with any extra.

WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs for that purpose.
At worst, the HSA behaves much the same as a tIRA after age 65.
4. Rule of thumb: traditional if current federal marginal rate is 22% or higher; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise.

For those willing to expend a little more energy than it takes to flip a coin, consider comparing current marginal tax saving rate vs. predicted marginal withdrawal tax rate.
If current > predicted, use traditional. Otherwise use Roth.
See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
See Traditional versus Roth - Bogleheads for even more details and exceptions.
The 'Calculations' tab in the Case Study Spreadsheet (CSS) can show marginal rates for savings or withdrawals*.
Remember to include all income-dependent effects in your marginal tax rate.
The CSS does include most federal and state brackets, credits (Child Tax, Education, ACA, Earned Income, etc.), phase-ins, phase-outs, and IRMAA tiers.
It may not include some state tax details, FAFSA Expected Family Contribution, and other items irrelevant to most but important to some.

5. See #4 for choice of traditional or Roth for 401k. In a 401k there are no income-based limits for deductions or contributions.
6. Applicability depends on the rules for the specific 401k. See Mega Backdoor Roth IRA.
7. Again, take the risk-free return if high enough. Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
(e.g., target retirement date) that provides a blend of stock and bond returns. If you wish to consider separate bond funds, compare the yield on a fund
with a duration similar to the time remaining on the loan, and put your money toward the one with the higher after-tax interest/yield.
8. Because taxable earnings will still help your FI journey. If your own retirement is in good shape, and you choose to provide significant help for children's college costs,
a 529 plan may be appropriate. Similar to "put on your own oxygen mask before assisting others," do consider funding your own retirement before funding 529 plans for children's college costs.

******

Note that if you impute your labor to the analysis above it gets significantly more complicated. In other words if you're an "active investor" like most of the people on BP are you need to consider the tax implications of providing an "outside benefit" to your tax-advantaged accounts if they're self-directed and whether or not keeping your money allocated to asset classes where your labor imputation can allow you access to the asset you're seeking to acquire. In general anything outside of the company match for your 401(k) should be subject to this extreme scrutiny. Care must be taken to maximize your after-tax income optimally and not to minimize your taxes at your accountant's behest. You also need to make sure your balance sheet appears loanable via your PFS with your banker, which is a whole other set of brain damage and varies by banking institution.

3 Reply

OP

Member since 2020 · 104 posts · 36 votes

6y

@Steve Vaughan that is a great point. On that note, my car loan is $9,500 and the payment is... was... 300/month. I was over paying a bit. However, I made the decision and just paid off that loan. I'm now down to my student loans. I just checked my actual numbers and I pay around $226/month on a $52,000 balance. That's around 5% COC return if I paid if off. Now I have to weigh if that is worth paying off. For now, I'll take the 300/month I was paying toward my car loan and put it toward my student loans.

2 Reply

Dylan H.

Rental Property Investor · Savannah, GA · Member since 2018 · 174 posts · 129 votes

6y

@Phillip Rosin

I think with your average debt being paid down at 5% you’re pretty safe and have excellent financials. That $2000/month in cash flow should be pretty easily attainable with your $100k+ cash position if you leverage it well. I would think depending on what market you’re in and the quality of property’s/types you prefer that cash flow could be achieved by one smaller commercial multi family property. Would see if you could find a seller willing to carry 20%, commercial bank finances 70% and you put 10% down.

Best of luck!

OP

Member since 2020 · 104 posts · 36 votes

6y

@Bryan Hancock Thank you for your in depth reply. You have a lot of great info in there. I have saved your comment and will reference it as I work through my plans. I did have a question as to where in that list REI would fall for someone with low DTI and a well paying W-2 job who can afford to take some risks?

OP

Member since 2020 · 104 posts · 36 votes

6y

@Dylan H. Thank you for that idea. I may try to pick your brain a bit on that.

Alexandre Marques dos Santos

Rental Property Investor · Member since 2020 · 215 posts · 137 votes

6y

@Phillip Rosin

Hello, i just joined BP and found your question very interesting. I am sorry if many pointed to same of my thoughts. I didnt read all of answers:

To be precise in the answer i will have to ask you to check if all the loans ( student and car) allows you to pay down, AND, discount the interest charged from the principal. In other words, they have to charge only principal and not principal plus interest.

If thats the case, my answer is simple: PAY DOWN THE DEBT! That reason lies in 2 factors: 1) In REI you will be able to raise money at much lower rates: specially if you have a good money to invest ( as downpayment).

2) The effect of taxation: paying down the loan has an effect of an investment of higher return. Imagine for exemple you pay around 40% in income tax (rounded number). A 5% loan to match is equivalent to an investment returning about 8.2% ( where you would pay around 3,3% of it in taxes-all rounded numbers). Not many REI will give you a certain return.

If i remember well your student loan is around 55k and car 9.5k. If they charge principal only, You might need to disburse only 50k on both, giving u ability to invest 55 k and get loan to add. Remember you will have 550,00 per month to pay for it. And cost will be lower than 5%!!! Its a win win situation. If you dont find anything to invest in short term, your money was properly invested. If you find the financials will be better than what you have now.

Hope i was clear to paint the picture. Anything let me know

Rgds

Shane H.

Member since 2018 · 433 posts · 208 votes

6y

Is a bird in hand really worth 2 in the bush? I believe so. You are in an awesome position to be debt free AND have a down payment on your first income property, AND you are on track to a million in your retirement account. The most important question is whether you will stay motivated without the anvil of the debt looming overhead... if the answer is unequivocally yes, then I would knock that debt out and breathe a short sigh of relief. .Many members of this site don't like to plan for the worst case scenario but I do.

worst case scenario, a year from now the economy takes a big hit. I dont know maybe bernie sanders got elected. You lose your job and get kicked out.

would you prefer to have:

a: $65,000 of debt. No job. A large sinking real estate and sinking stock portfolio with let's call it $15,000 a year of rental income. (Assuming 15% cash on cash on your 100k) 1250/month - 550 payments = $700 cash flow.

or

b: 0 debt. No job. A small sinking real estate portfolio and sinking stock portfolio. Same 15 percent gives you COC of $6750 or $562 cash flow.

theoretically the numbers say scenario 1 is better. But which scenarios feels better and is more secure? Sometimes percentages get the better of us. We just compared 15% to 5% and found a cash flow difference if $138. If the difference were $2,000 I would obviously suggest otherwise but you're unlikely to find that big if a difference in my opinion. So in the disaster scenario if you lost everything or had to dip into stocks your exposure is much more limited. You could take a cheap job to get by until you found a better one. And not worry about having your car repossessed. You could drive uber or deliver pizza to get by.

I run a full time business that changes by the season. Snow removal in the winter. Refrigerated truck repair in the summer. It's feast or famon. A few years ago I had $70k in debt. The famons were rough. Putting $5 of gas in to get to a job to make $75 so I could take the $75 to buy a part for another job to make $300 so I could pay on my loans. Man was that miserable. I just came out of this year's famon. During my low debt famon period I bought a small piece of land I wanted, a truck that the opportunity jumped out at me, and an engagement ring. All with little fear, since I don't have the anvil looming. I paid $5,750 cash for the property it nets $600/yr land lease. I literally improved my cash flow during the famon! I bought the ring on credit that will be paid off next month when the feast is strong. 5 years ago I would go eat at my mother's house because I couldn't afford food during the famon. Shaving a few thousand of payments off has worked miracles.

2 Reply

OP

Member since 2020 · 104 posts · 36 votes

6y

@Shane H. But Bernie promised to eliminate my student debt lol...

You make some really great points as well. Please allow me to throw a few wrenches into the mix to see what you think. I went ahead and paid off the car loan, to which I was paying $300/month. This leaves me with around $52K in student loans with a roughly $250/month payment and $95K in cash. They are federal student loans, meaning if there ever was a dooms day scenario, I would be able to defer or greatly reduce my payments until I could once again secure steady income. Not ideal, but a 'safety net' none the less.

If I pay off my student loans, I'm left with around $43K in the bank, which is certainly nothing to scoff at. I will also then have around $3,000 per month left over after my base expenses are paid. I suppose that isn't a bad spot to be in.

Alternatively, if I keep my loans, I will have a $250/month payment, $95K in the bank, and around $2,750 per month left over.

That leaves the big question is whether the return I could get with that $52K would outweigh the cost, both in interest and security. At my current saving rate, it would probably take me 1.5-2 years to save that much back up. Even at 2 years, at a 15% COC vs 4.8% interest, I'm looking at a difference of around $5K/year (~10% of $52K) or $10K 'lost'. However, I could be putting that money into a high yield savings account as I'm saving up, to offset that a bit as well... AND there's no reason I couldn't take the cash I do have available still and use that to get my feet wet... So maybe all the debt free arguments are gaining some weight haha.

Tracey G.

Accountant · Baltimore, MD · Member since 2016 · 74 posts · 29 votes

6y

@Phillip Rosin. My advice to my son who is about to graduate from college with a great job and $27k of loans is not to pay the loans down early. Put the money into savings/investments and then if he wants to, he can use the interest/returns to make additional payments. If I could go back in time, I wouldn't have paid my loan down early.

Shane H.

Member since 2018 · 433 posts · 208 votes

6y

you are obviously looking at better cash flow paying the 300. You could flip it too and invest the 100k then dump $2500 on the loans and be done in 2 years... I personally wouldnt drag them around for the 30 years the government payment plan suggests. When you had the option of paying them in 3 minutes. But 2 years isn't awful. Even 5 if you're disciplined...

I'm a bit crazy about my finances so something I would do is draw up 2 financial statements one each way and see which one is rather look at. Throw presumed incomes and expenses from both scenarios, and the assets and liabilities. and I would also run the numbers through loan and investment calculators that you can download on your phone. Use different time frames and different options. See what you feel best about!

The car was a great decision. No brainer for me. The student loans are super tempting to pay back slowly and keep the cash flow. You'd be giving them a full 100k on that payment plan, albeit in inflated dollars over 30 years. investing your money and paying $1000/month pays it off in about 5 years and saves you something like $45,000 of interest. Which is probably about what you'd bring in from your real estate. So you would net 0 for cash flow but gain equity in your property while aggressively paying down your debt. After 5 years you would pick up that $1000 in cash flow.

John Teachout

Rental Property Investor · Concord, GA · Member since 2015 · 3k+ posts · 3k+ votes

6y

The feeling of being completely debt free is worth a lot to me. Of the 31 years we've been married, we've had debt in about 8 of those years. (not consecutively) And all of it was for real estate purchases.

[email protected]215-283-2868

Carl FischerPro Member

Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes

6y

@Phillip Rosin

If you are making more with the borrowed money than your paying don’t pay it off. Make money on the arbitrage don’t pay not making money then repay. I use equity lines and loans to provide cash when needed-all cash and close quickly seems to provide at least a 10% discount up front. Use leverage to make money don’t worry about the debt. Cash flow is very important.

Fernando E.

Rental Property Investor · SF Bay Area · Member since 2016 · 234 posts · 103 votes

6y

@Phillip Rosin Although I don’t agree with all of Dave Ramsey’s principles, most of his teachings are solid and this includes paying down debt and being In a more solid financial footing. In my humble opinion, if I was in your shoes, I will pay off the debt leaving you with about $40K cash, reducing your monthly expense to a low $1500. Further, save 6 months of emergency fund about $9K, $10K for good measures leaving you with $30K. At this point you are debt free with 6 months cushion on whatever life throws at you.

At this point, you will feel much in control of your financial position, hang out in BP forum, learn what niche works best for you through education and REI, networking. If you have a full time job strive to make more $ to invest in REI and get a deal by Q1 2020 maybe a BRRR wherein you only need to put minor touch up on the house. It doesn't have to be full BRRR but you don't need a home run right away jusr don't lose money.

Good luck, you got this!