Pay Off Student Loans or Invest in a House Hack?

A recurring question that I keep getting is, “Craig, should I pay off my student loans? Or should I invest in real estate?”

The easy answer to this, like any highly debated question, is it depends. It depends on your risk tolerance, how quickly you want to achieve financial independence, and when you want to start investing in real estate.

The TL;DR (too long, didn’t read) answer to this is, if your risk tolerance is low and you want to play it as safe as possible, pay off the student loans. If your risk tolerance is higher and you want to achieve financial independence sooner, then invest in a house hack.

This article is going to visit two people: John and Bridget. They both have $0 in savings, make $60,000 per year ($5,000 per month or $4,000 after taxes), save $2,000 per month, and have $50,000 in student loans. The interest rate on these loans is 6 percent, bringing their monthly student loan payment to approximately $350.

Each house hack they acquire will be the same price of $300,000, and each one will cash flow for $500. In order to illustrate the point, all variables will be constant except John will play it safe and pay off his student loans, whereas Bridget will house hack while making the minimum payments on her student loans.

I know no one likes reading numbers in paragraph form. So, here is a recap.

Let’s Use These Assumptions for John & Bridget

Income

Income: $60,000 ($5,000 monthly)
After tax income: $48,000 ($4,000 monthly)

Savings

Initial savings: $0
Savings rate: $2,000 per month

Student Loans

Student loans: $50,000
Student loan interest rate: 6.0%
Student loan monthly payment: $350

House Hack

House hack purchase price: $300,000
Cash flow: $500

Difference

John pays off student loans
Bridget house hacks

John’s Plan: Pay Off Student Loans Now

Like we mentioned above, John is making $60,000, which ends up being about $4,000 per month after taxes. John is conservative and wants to pay off his student loans before purchasing real estate. He is super frugal, lives below his means, and is an avid follower of the financial independence movement. He saves 50 percent of his income, or $2,000 per month. All of those savings he funnels toward paying off his student loans.

With a monthly payment of $350, the additional $1,650 of his savings goes right to principal.

After just over two years, John will have paid off his student loans entirely. Then, he will need to rebuild his nest egg to save up for the down payment on his first house hack.

By making the decision to pay off his student loans, John is delaying house hacking by just over four years—two years longer than Bridget, who we’ll visit in the next section.

For the simplicity of this article, each one of John’s house hacks will provide the same exact results, and we will exclude appreciation, loan paydown, and the tax benefits of house hacking. By the end of year 20 when he paid off his student loans, he would have a total savings of $781,000.

Note: This number would be much higher (to the tune of millions of dollars) if we include appreciation, loan paydown, and tax benefits. However, that is noise that does not add to the point of this article, so we are leaving that out.

Bridget’s Plan: House Hack ASAP

Unlike John, Bridget wants to accelerate her path toward financial independence. She is eager to start house hacking, so she dives right in. She makes the required minimum payments toward her student loans, because she is confident that she can make a 6 percent return while house hacking. For that reason, she purchases her first house hack after just two years of saving up.

By house hacking as soon as she can, Bridget is starting to gain some passive income, earning $500 monthly per house hack. Each year for five years total, she adds another house hack to her portfolio. By year five, she’s earning $2,500 per month in passive income.

Again, I am simplifying this example as much as possible, so I am neither considering the other wealth builders of real estate nor assuming that she puts her additional money into another investment vehicle, like the stock market.

After house hacking and continuing to save at the same rate, by the time her student loans are paid off (year 20), Bridget would have a total savings of $871,000.

John’s Savings vs. Bridget’s Savings

Maybe I am being repetitive here, but I need to drive home the fact that house hacking will prove to have much greater rewards than just the $800K-plus Bridget can save up over 30 years. However, I am only factoring in cash flow in this example.

Cash flow is just one of the four wealth generators of real estate. If we include loan paydown, appreciation, and tax benefits, both John and Bridget would likely have a multimillion-dollar net worth, because house hacking is a powerful strategy regardless of how you look at it.

Let’s look at the difference here. In year 20, John has $781,000 and Bridget has $871,000. Over the course of 20 years, even with paying the minimum down on her student loans and the most interest possible on those loans, Bridget ends up having $90,000 or 11.5 percent more in her savings account—and likely hundreds of thousands to a million dollars more in total net worth.

Conclusion

I hope this example was simple and easy enough to understand. As you can see, barring student loan interest rates going through the roof, in almost every scenario, house hacking before paying off your student loans will benefit you financially in the long-run.

It really is simple math.

Can you invest and earn a larger return on the money you save versus the interest rate on your student loans? If the answer is yes, then you pay the minimum balance. If the answer is no, then you funnel all of your money toward the student loans.

With house hacking, you almost always will get a return higher than 6, 10, or even 25 percent, because you are putting such a low amount down (3 to 5 percent).

The drawback to house hacking is that you can only do it once per year and thereby only earn those insane returns once per year. After you guarantee yourself being able to house hack once per year, then you can go about paying off your student loans.

A guaranteed return of 6 percent is pretty good in almost every scenario that’s not house hacking.

In my scenario, I was more like Bridget. I house hacked my first two properties while paying the minimum balance on my student loans. When I realized that paying off my student loans would not inhibit my next house hack exactly one year later, I decided to pay them off.

And because of house hacking, I paid off $85K of student loans in 16 months. If I hadn’t, it would have taken me over seven years!

I hope this article proves useful and gets your wheels spinning.

Now, which will you do? Pay off your student loans or get into your first house hack? Do you have any questions for me?

Let me know in the comment section below!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.