Debt Payoff or not?

Question

Hello,

Looking for some input from the BP Community.

My wife has $15k remaining of outstanding student loans. Our payments are $300/ month and the interest rate is at 3% fixed (2% after tax deduction). We have some available funds right now to pay them off, and we won't need the money for anything in the foreseeable future. However, I am actively looking for properties to purchase and I have $50k to buy another property above and beyond the 15k. We pay $50 a month in interest and this amount is deducted from our taxes, so the 15k costs us $33/month in interest net. My debt eliminator self wants to pay off the loans so I don't have to think about them anymore and to improve our personal financial situation. I can look at it like a $15k investment makes me $300/month for the next 6 years(that is the remaining loan term), a 24% CoCR. On the other hand my inner Real Estate Investor says that 2% is cheap money, and that I should hold onto the money in case I need it to buy or renovate my next property which could surface in the near future. My current Big Picture Goal is to increase my passive income from rentals so I can pursue it full time. Both buying more property and reducing my monthly expenses help me get there quicker.

Would you pay off the loans or keep the money to buy another cash flowing property?

Thanks for your input!

Grant Brewer · Answer

I too have a similar situation with my wife and I. We have decided to make the minimum monthly payments on our school loans, for much of the same reasons you already listed. It is "cheap" money, tax advantages, and overall that amount of capital (~15k) has a much bigger potential for gains if I use it towards 
	RE. I have a similar long term goals (gain passive income), and that is a good amount of capital that can jump start that path to success, especially in the beginning years.

With that said, my wife and I are fairly conservative with our personal finances, and seeing that payment go away is something I would love to see happen. But thankfully we live well below our means and this is one of the very few debts that we hold, therefore it is a bit easier for me to take on this smaller monthly obligation. As others have said, it is really a "win-win" situation, so if paying it off off now helps you sleep at night, do it.

John Chapman · Answer

I'm kind of wrestling with the same issue with my wife's student loans.  (I think the balance is only about $2K, so it's not as big a decision.)  As you point out, it's not rational to pay it off since the interest charge is so low.  At the same time, I've been paying on the stupid thing for 9 years.  I'm sick of seeing that monthly payment and just want to see it gone.  I console myself with the fact that it will open up some cash flow if I pay it off, but deep down I'm know this is entirely a psychological motivation to see it gone.  I think sometimes, you can't behave like an economic robot and you've just got to do what feels right, particularly when both the choices are good (just one is better).

Edward Burns · Answer

My answer to your question depends on several factors.

Do you have the fortitude to put the $300/month in savings (or investments)? If not then you will not see a return on the 15K.

Is your debt-to-income ratio such that paying off the 15K will allow you to get a loan for a)more property or b)a larger property?

Is the price of real estate where you are investing such that there is a drastic difference in return on a purchase of $160K (40K of your 50K holding 10K as reserve) versus a purchase of $200K (your $50K keeping the 15K as a reserve)?

Without knowing these answers, I can not tell you what I would do? But neither option is necessarily wrong.

Alex Noiz · Answer

These question are kinda emotional. Because you can't really win in this case. You just need to ask yourself: how would you feel if you pay your wife's student loan? Would it feel good by taking this weight off you shoulders? Or would you regret big time by missing a great opportunity to invest in real estate?

Ask yourself these quaetions. Hopefully this will help.

Bob Hines · Answer

@Graham Mink  Why do you have to decide now?  You said you were afraid you might need it on your next deal.  Why not wait to see if you need it on your next deal?  The interest cost isn't going to be that much to hang on to that $15k until your next deal.  I suggest re-evaluating then if you don't end up using it.  Keep an open mind because after your next deal, you may still want to hang on to the cash to speed up the deal after that-at least that is where I recently found myself in regards to paying off my wife's student loans.  As much as I hate those payments, I see how close I am to my real estate goals and I'm willing to hang on to them a bit longer.

Grant Brewer · Answer

No doubt the paying off debt is much lower risk. Great point. My explanation of our family's "conservative nature" and low debt was my way of mitigating that additional risk associated with RE when deciding between the two. Everyone is different, but for me that helped ease my fears a bit. I am interested in what you finally decide for yourself. Good luck.

Graham Mink · Answer

@Grant Brewer

@John Chapman

Glad to hear others are in my same situation, not to wish debt woes on anyone!

Grant, I tend to agree with you that I can get a better return but there is risk involved with that REI. Paying off the debt is guaranteed to give me that return, plus help me sleep at night, like John said. You both bring up good points and I am still on the fence, conflicted as to what is the better deal, I don't think I can lose much either way.

Grant Brewer · Answer

Graham,

The only argument I would make against your math of getting a 24% return on cash over 6 years is this: If that were the case, I believe I can get a better return (compounding interest in mind) over 6 years using that 15K in RE. Even if it were a close call as far as the math is concerned, with the tax advantages, equity buildup, etc., I reason with the fact that RE will supply better returns in the time frame you gave of 6 years.  Again, it's a "win-win", I am just trying to play devils advocate here.

Graham Mink · Answer

@Edward Burns

Thanks for the quick response!

My logic in regards to your first question is a little off. Maybe I can explain a little better. If I keep the loan can I use the 15k to acquire a property that pays $300/month? Which would cover the $300/month student loan payment that I will be making for the next 6 years since I am not paying it off. Paying off the loan "instantly" gives me a 24% CoCR for the next 6 years.

It has no effect on my DTI since I apply for new loans personally and the student loan debt is in my wife's name.

The price of real estate in my area is all over the place. I may need the 15k for my next deal or I may not, that will depend on what I decide to do with the money and what becomes available.

My hesitation is that if I pay off the loans then buy a property and need to borrow $15k more to do whatever I need to do then the new rate is going to be much higher than the 2% effective rate I am currently paying.

Debt Payoff or not?

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