Pay off current debt OR save a down payment?

Question

Scott Trench · Answer

I believe that there are various types of debt. For the purposes of your question, let's lump debt into three categories:

1) Debt that you should probably not repay prior to investing in real estate. Consider this things like low interest car loans, a home mortgage, or other personal debts that are financed at or below 4-5%.

2) Debt that you should almost certainly repay prior to investing. Consider this debt like CC debt, delinquent debt, or debts that are accruing 8-10% interest or more.

3) Debts in the "gray zone" of 5-9%. Yes, this is all overlapping. Consider this like student loan debt, higher interest vehicle loans, etc. These debts are where reasonable people can disagree over the course of action that is most appropriate. Personally, I'd definitely house-hack before repaying these if possible, but I might not buy a rental property outright, depending on the debt.

Knowing nothing else about your situation, I might start off by pondering what it looks like to:

1) Pay off the credit card debt

2) Pay off all student loans and vehicle loans above 7.5%

3) Invest in real estate

4) Gradually pay down the remaining debts over time

Michael Hastings · Answer

@Ryan Rowe, I like the approach which is a blend of the information @Scott Trench provided above, and the "it depends" answer posted by @Chris LumLee.  Why you ask?

Because I have the pleasure of having many colleagues who are Attorneys, and their Law School Student Loan Debt is in the 6 figures (Some over 200K).  They also want to get into REI as a retirement supplement vehicle, but are paralyzed by what seems to be a difficult situation to overcome, which is fully paying all debt down (Student Loans, C/C, Car Loans, etc.) before starting their investing.  Dave Ramsey would unconditionally state that you need to pay off ALL debt and THEN purchase real estate for CASH and avoid mortgages.  Although I love his work and follow many of his teachings, I find this to be an extreme path to follow, and for my high Student Loan brethren, suggest an approach similar to that of Scott, with a minor adjustment:

1) Pay off the credit card debt (anything with a revolving balance), continue paying vehicle loans and student debt,

2) Pay off vehicle loans (and never get another one, ever), continue to pay student debt,

3) Invest in real estate using mortgage as leverage, as an alternative to traditional retirement investing (401K / IRA, so lower those investments at work, just to enough to get your employer's 401K match if offered which is free money)

4) Continue to pay down the Student Loan Debt aggressively.

Paying off # 1 and # 2 will free up some cash for investing, and once investing (via a House Hack, I suggest initially, so you should be able to reduce your housing expense and recapture more money to pay student loan debt).  Plus there are a lot of tax benefits to property ownership which will increase your annual take home pay come filing time.

The "it depends" part of this equation assumes that you have student loan debt of $40K or more (like many do).  If your student loan debt is under 40K, then I would consider that to be equal to a vehicle loans and may suggest it is paid off BEFORE REI, that way you are debt free going into your new adventure (possibly with the exception of your living expense if you already have a mortgage).  If your student loan debt is higher than 40K, then you have to continue to pay it and push it down under your initial REI goals when getting started.  This way, you could use some of the cashflow to help pay down the student loans (those student loans are just plain evil), and hopefully see some equity gains over the next several years.

I think the answer to your question here can be varied, as this also depends on your credit situation, current job status, income, willingness to get out of debt, real estate market, etc.

Hope this helps!

Steve K. · Answer

@Ryan Rowe ,  I'd challenge you to consider letting that $10k student loan "ride", and pay it off on the prescribed timeline.

Using @Michael Hastings 's 4 points, (and a nod to @Scott Trench 's similar buckets), someone sold on REI is investing in RE in "step3", rather than mutual funds/etc because we think buy/hold real estate can return 10% or 20% on our precious capital, and why settle for less in the conventional investments? If you are good at REI in "Step3", and if your student loan APR is less than you can make on your REI, I'd ask "why not keep investing in Michael's Step3 instead of going on to Step4? (of paying off the student loan debt in an accelerated manner.)

So, if you're comfortable with a little more leverage, and can continue to qualify for another mortgage, why not buy another rental, instead of paying off the $10k loan?

Other young investors on BP don't have the $10k down payment to buy a $50k rental and launch their REI career....if you paid off your student loan, you'd be antithetical to the fastest growth methods of BRRRR investing. But, decide for yourself, if you like the risk/reward of more leverage to grow more quickly.

Good luck.

Ian Kurela · Answer

My thoughts are that if you are able to get a better STABLE return from an invest than the interest rate charged on a particular piece of debt, go with that deal. I am guessing you are buying and holding for the cash flow. You will be able to pay off that debt with the profits from that deal each month while simultaneously building equity in that property

Matt K. · Answer

You'd probably be able to outperform the car/student loan debt, but likely won't be able to outperform the credit card debt. I think it would come down to how much debt you have, how much you can save, and how much capital you need. It takes a rather significant amount of down money to get a rather small amount back monthly.

Chris LumLee · Answer

Before I bought my rental I had a similar question. I hate this answer but I have to give it here: "It depends."

For me, I was saving for a down payment and the I had to get a new car so I focused for awhile on cutting down the car loan amount. I'd say it was maybe 80/20 (car/down payment savings). But now it's probably closer to 50/50 because I'm far enough ahead on car payments that I'm fine as long as I keep paying the minimum. If it's credit cards on the other hand, pay that sucker off pronto. It does depend on the type of debt you have. Credit cards, student loans. Get rid of them. Car...up to you how quick you want to get rid of it. I'm saving for a second place now so I'm down to about 75/25. But once I pay off my car I'll rip and roar to save all for the house.

So it really depends on how comfortable you are with having the debt and if you're confident you can manage it well. If you're okay with it, then by all means save for the house once you get that bad debt out of the way. Otherwise, if the idea of debt keeps you up at night, then get rid of it all then focus entirely on saving for the investment.

Best of luck to you!

Pay off current debt OR save a down payment?

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