Pay off student loan or save for real estate investing?

Question

I wanted to know your take on what would be the best way to go. We are looking to flip our first house whenever we save up the funds. We will also be attending our first REI meeting next week to hopefully talk to private investors and get educated. I'd rather use my own money to buy the flip and fund the rennovations, but we are also considering the private lending. I am currently making over 1k a month payment on a student loan and I have an excel sheet showing it should be paid off by the end of next year (2014). I am about 14k in debt from the loan at 5.375% interest rate. Should I keep paying on my student loan or would you rather me save that money for a flip? Or should I keep paying on my student loan and just go the private investor route. Or should I save the money and also use a private lender. Thanks for your time.

-Ben

Michael B. · Answer

Hey @Benjamin Kelley , it looks like I'm late to the party and it sounds like you've already made a decision, but I'll add my thoughts anyway.

Real estate investing is a long term process. Most successful investors have been at it for multiple decades. I know you're fired up and ready to start investing, but my thoughts you should slow down and get ready to invest. Put your personal finances in order so you're ready to move. Much more boring, but necessary.

And I'd disagree with @Ned Carey 's statement that investing in real estate now is the equivalent of getting a CD for 5.375% interest. Understand the difference between an accounting profit and an economic profit. Ned's right if you're only looking at an accounting profit. However an economic profit considers not only the dollar return but the risk and your time.

Economic profit = Account Profit + Risk Premium + Value of your time.

Since an investment in your own debt is risk free and requires virtually no time the Economic Profit = Account Profit. Not so for real estate investing. There's risk that things will go south AND it will require a good dose of your time. Consider both.

So spend some time knocking out your debts to prepare to invest. Since you have 2 incomes capable of supporting current spending it shouldn't take long. Cut back your lifestyle and throw everything against the debt and make it go away. The sooner the better.

I once heard Bob Knight, head basketball coach at Indiana and Texas Tech speak at a banquet. The thing that jumped out at me was the value he put on preparation. One quote was that he didn't want the player who had the 'will to win', he wanted the player who had the 'will to prepare to win'. The idea is that everybody will play their heart out on game day, but not everybody will play their heart out for hundreds of hours prior to game day. Preparation is key both in basketball and investing. Spend some time getting your personal balance sheet ready to invest. It'll pay off for decades if you do.

Benjamin Kelley · Answer

@Michael B. I also agree with your advice.  I had initially intended getting rid of our debt, maybe except for the house. We both recently paid off all of our credit card debt and started focusing our energy on student loans.  We see how much our friends make in real estate and just get star struck.  We want to think, if we leverage our money, it will pay us in the end. I am torn. Also when I read about not letting "fear" get in the way, it's hard not to want to get into real estate as fast as we can.  I'll find my way I am sure and learn from my mistakes.  Thanks for a different point of view.  It always helps.

Also, I love basketball.  The basketball story really struck home for me. Thanks for the post.  Thunder up! :)

Benjamin Kelley · Answer

@Dave Savage I think if I found the right property, I would pull the trigger.  Right now, we have dual income coming (me and the lady have decent paying jobs) in and either one of us could handle all of our living expenses with one of our paychecks if we had to.  In my head, I want to think that because of that reason we are at much less risk.  We just need to save up the money first.  I think we could save it up rather fast. If I can get a much better return, I think that flipping would make logical sense. Thanks for the input.

@Ned Carey Thanks for the input.  That's our main focus right now, is saving up those cash reserves.

@Joe Fairless we are currently doing the saving cash reserves part.  We also have a married couple friend that has about 15 rental properties and has flipped 5 houses, that is our main mentor.  I think you are on point when you say I could get more on my return if I invest in real estate.  I think fear of going in more debt is what bothers me.  But if the right deal comes along, I will make a deal.  Thanks for your input.

@Erik Palquist  My student loans are federal.  I will keep this information about them in the back of my head.  Thanks for the post!

@Bill Gulley  I am really swaying towards investing in RE more than paying off my student loans.  We have a great mentor who has plenty of experience in the market already.  So I think if we found the right deal, we would do it in a heart beat.

My Comment about was abour borrowing.  Sorry for any confusion.  Thanks for your well thought out post.

Thanks guys!  All of your posts have been very insightful.  We have a lot to think about still and a lot to learn.

Bill Gulley · Answer

Consider the risk of your opportunities as well, you're making an assumption that you have a good deal, that you can do the fix, that you'll sell in a timely manner and at a profit. If this is all true, then your use of funds might be better in RE, if it's not, well, you may be paying the loans longer....

The rate you pay on your loans isn't really like investing in another investment as that is costing you with after tax dollars, your RE deals need to net more to pay the rate and principal reduction.

If your obligation is 1,000 and it's more than 10% of your income you need to get the loan paid off to be in a position to finance properties. I assume your private lending comment was to borrowing not lending money, it it was about lending, payoff your loans before starting such ventures. :)

Erik Palmquist · Answer

@Benjamin Kelley If your student loans are federal loans you have a lot of options if you end up in a bad situation for some unforeseen reason. A lot of those options will allow you to reduce or some times even eliminate your payments for a period of time without affecting your credit score. Having the extra cash on hand can certainly be beneficial if you have the tolerance for carrying the student loan debt while investing in a property.

Joe Fairless · Answer

good question @Benjamin Kelley   and, like @Ned Carey  I won't give you a straight answer because it depends on your risk tolerance, knowledge and other factors such as your cash reserves, mentorship access to help you with your 1st deal, the deal fundamentals and many other things.

I will say, however, that I always look at the potential return while weighing risk. And, when you state you're paying a 5.375% rate I think all investors on BP can agree that it is possible (and likely if you know what you're doing) to easily exceed that return with real estate. I personally would invest the money into a higher return and make minimum payments on my student loan if I were in that situation but, like I mentioned above, there are many other factors to consider.

Ned Carey · Answer

@Benjamin Kelley  would you invest your money in a bank CD at 5.375% ?  Essentially when you pay off debt it has the same net affect to your net worth as investing at the rate you are paying off.

I be you can do better that that in real estate, so your funds may be better put to use by investing rather than paying off the debt. However there are other factors like the risk of the additional debt. Investing takes cash reserves for when things go wrong.

I haven't given you an answer but perhaps some things to think about. The amount of debt/risk you take on is always a personal choice.  Good luck - Ned

Dave Savage · Answer

This is going to be a personal choice call with regard to risk and deisre to leverage.  5.4% is a pretty good rate compared to what you are going to be borrowing from a private lender so it might make sense to save up money instead of paying down your debts if you truly want to do a flip.

Remember for most hard money lenders, and many private lenders you are going to have to have some of your own money in the game so you will need to save us some funds to execute your first flip, and also you need a contingency fund of ~$10k depending on the property to cover holding costs/unexpected repairs etc.

Pay off student loan or save for real estate investing?

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