Cosigned on my Daughter's Student Loans - A Creative Way to Pay?

[Mackal Smith]

Rather than bore you all with the details, just suffice to say that I cosigned student loans (both government and private) for my daughter's college. Of course as a cosigner, these show up on my credit as loans as well as hers. All combined they are a little more than $100,000. Some of the private loans have interest rates as high as 9%. She has been doing a decent job of paying the loans (although I have had to step in and help her out fairly regularly) but she doesn't have decent enough credit to be able to refinance on her own to get a better rate. She has been able to defer the government loans up till now, and her monthly payments have been right around $800/mo. The government loan deferrals are about to stop however and her loan payments will increase to $1300/mo. She can't afford that big an increase so I have been thinking about ways to help her out. Please read on and give me your thoughts...

I live in St Louis, and the rental market is good here. I currently own 25 units (spread across duplexes, triplexes, and 4 unit buildings). All provide good positive cash flow. Here is what I'm thinking. I can pretty easily take out $100,000 HELOC on my personal property. If I use that as a down down payment, I should be able to leverage it against about a $500K loan. Prices are still relatively cheap here in St Louis. In fact I have seen a few 15 to 24 unit apartment buildings for sale in the past few months that are situated in the the same area I have my existing rentals (so I know the neighborhoods) and would come in right around that $500 to $600K range.

If I were to pick one of these up, I'm 70% sure I could get plenty of cash flow to pay debt service, taxes, CAPEX costs and still have enough left to pay the $1200/mo in her student loans. If I had her pay my HELOC, I think I could keep her payments around the $600 to $700/mo range.

I guess what I'm looking for is validation that I'm thinking the right way. It seems to me that when it was all said and done, I would have been able to pay off her existing student loans, she would be paying the same or lower rate (since she would be paying of the $100K HELOC at a much lower rate), and I would end up with an apartment building.

What am I missing?

[Scott Trench]

While I suspect that some other BP members might question this stance at all, I think it's great that you are paying your daughter's college and student loans! 

If I were to summarize your situation as I perceive it here, your goal is to pay off around $100,000 for your daughter. The resource, at least the resource which most prominently jumps to mind for you in deciding how best to pay these down, is your $100,000 in equity that you could get a HELOC on.

The student loans are at a blended interest rate, with some debt as high as 9%, and some lower. Let's call the blended rate on the $100,000 in debt 7% (correct me if I'm meaningfully off). 

Here are some steps to consider prior to the approach you reference with the debt:

1) If your daughter is doing a great job at this, she should be able to refinance her student loan debt at a more favorable rate. Try Sofi.com. This should bring the blended interest rate down, and avoid this big jumps in payments. This should serve the two-fold purpose of reducing the rate on this debt, AND removing your obligation (but certainly not your option) to pay off the debt on your own name.

2) If your daughter is not capable of refinancing the debt, you could try option 1 with you as a cosigner.

3) If you are able to refinance, then you are left with a moderate to low interest rate debt, and can approach tackling that debt like you would a home mortgage. Some people choose to pay those off early, or create passive cash flow to pay off those debts, and some people choose to ignore them and invest in assets they believe will produce higher returns.

4) If you are unable to refinance, then you will have this large student loan debt at 7%. 

If we are stuck with option four, then I suspect that you will be able to get that HELOC at a 4-5 % rate. You are basically asking if you should deploy this equity and arbitrage the two rates. IF you can afford and sustain the payments, then the math will likely tell you that it is to your advantage to use the HELOC to pay off the student loans, and go from there. The obvious consequence of this decision is that your daughter will no longer have her name on any student loans. This could be good (if your goal is to take on this financial burden and set her up debt free to start out in life) or bad (if you want her to be legally responsible for her debt), depending on your personal beliefs. I'm of the former opinion, and grateful to my parents for allowing me to graduate debt free from a great school.

So, if we accept that paying off the debt with the HELOC is mathematically likely to deliver a favorable result, the next logical question is why not arbitrage the rate difference even further, and instead of paying the loans with the HELOC, buy rental investments, and use the cash flow to sustain the payments.

And the answer is that absolutely this could work. The problem is that this is fairly risky. You are only 70% sure this could work. If it doesn't work, and you don't hit a solid double with this property, you may compound your cash drain. I personally prefer to invest from a position of financial strength, such that my financial position will improve with, but never depend on, my next real estate investment. 

You are clearly a smart and capable real estate investor, with more experience than I. If you think you can make this work, go for it! If not, I'd encourage you to think of this instead of as an expense that you and your existing business need to pay for and sustain. Invest to improve your overall position outside of that as allowed, and it's a good thing that you have a protfolio already in place. This kind of debt might delay your financial goals a bit, but it can derail others for decades.