Buy Real Estate or Pay Down Student Loans?

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Abciximab
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Buy Real Estate or Pay Down Student Loans?

Post by Abciximab » Sat May 15, 2010 6:42 pm

I keep flip-flopping between paying down our higher interest student loan debt and purchasing an investment house. Our goal would be to rent the house for positive cash flow, but we could also afford to make the extra mortgage if the property was vacant. Here are our details:

My wife and I both finished grad school in the last few years, and we have about $140k in student loan debt. The approximate breakdown of the debt is $60k at 6.8%, $40k at 4.5%, and $40k at 2.3%. Our combined income is a little over $200k so we can't deduct any of the interest. We are maxing out both our 401(k)s, IRAs, and our family HSA. We live modestly, have no credit card or car debt, and have a 15-year mortgage on our home.

We purchased our first and current home in late 2008, so we didn't buy at the peak of the bubble, but our house value is down an estimated 30%. My fear is that I'm chasing my losses and trying to justify purchasing an investment home to try and make up for what we've lost in equity. I believe that house prices here have gotten very close to the bottom and I've been presented with an investment opportunity that may not come our way again for a long time. I also realize that I might have no idea what I'm talking about and home prices could easily go down further.

Is it worth passing up a guaranteed after-tax return of 6.8% by paying the loans early to buy a house? I'm afraid that by the time the loans are paid off the ship may have sailed and house prices could be markedly higher. Regardless of the issues with being a landlord, what makes the most financial sense?

Thanks for the help. ---Kyle
An investment in knowledge always pays the best interest - Benjamin Franklin

retiredjg
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Post by retiredjg » Sat May 15, 2010 6:51 pm

I vote to pay off the loans. It is a guaranteed return on investment. A rental house may bring income, but it is not guaranteed and is fraught with things that get in the way of making money.

If rental income is a good deal, it will be a good deal later too.

Gekko
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Post by Gekko » Sat May 15, 2010 6:56 pm

$140k in debt?

IMO - pay off the debt.

TigerNest
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Post by TigerNest » Sat May 15, 2010 7:09 pm

I would definitely pay off the loans. Nothing out there is going to yield 6.8%, after tax, guaranteed.

If it makes you feel any better, it took years for house prices to begin to climb again after the 1991 real estate crash (at least in my part of the country), and the starting point was not nearly as high. I doubt you'll be missing out on noticeable price appreciation for the next decade.

Of course, like all opinions on the internet, take it for how much it cost ya.

Indices
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Post by Indices » Sat May 15, 2010 7:20 pm

I'll be a contrarian: buy the house. Those who are saying that the rental won't have a higher return than the interest rate are essentially predicting the future. Every year you have a tenant, you will raise his rent, as is standard. Eventually the rental return will be greater than the interest rates on the loans if it isn't now.

The catch is that you are taking a risk that you will always be able to find a tenant. If the economy gets worse, you might not, or you will find tenants only for rental income that is lower than the mortgage you will take out.

I would not bother to speculate on real estate prices. As a potential property investor I would look to the long term and keep the rental property forever and view it as a source of income. We don't know if property values will decrease.

What we do know is that inflation is on the horizon at some point, as it goes hand in hand with economic growth. With inflation will come the ability to charge higher rents as people's salaries will be higher. Higher rents means more income, whereas your school loans will cost less because they were locked in at a low rate in the past.

Jack
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Post by Jack » Sat May 15, 2010 7:39 pm

You've lost 30% on one house so you want to double down on a second to make up for it? This sounds more like gambling than investing. Unless the house is an unbelievable deal with guaranteed positive cash flow right now (including all expenses, maintenance, damages, vacancies), I would take the guaranteed 6.8% and even the 4.5%. Have you carefully considered whether you want to be a landlord?

MichaelCorleone
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Post by MichaelCorleone » Sat May 15, 2010 7:45 pm

Housing is cheap in Phoenix, it was hit particularly hard. You might get a tax benefit from owning the house that you wouldn't get from the student loans. I'd run the numbers to see what your true cost would be factoring in the interest charges and tax breaks.

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grabiner
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Re: Buy Real Estate or Pay Down Student Loans?

Post by grabiner » Sun May 16, 2010 10:24 am

Abciximab wrote:I keep flip-flopping between paying down our higher interest student loan debt and purchasing an investment house. Our goal would be to rent the house for positive cash flow, but we could also afford to make the extra mortgage if the property was vacant. Here are our details:

My wife and I both finished grad school in the last few years, and we have about $140k in student loan debt. The approximate breakdown of the debt is $60k at 6.8%, $40k at 4.5%, and $40k at 2.3%. Our combined income is a little over $200k so we can't deduct any of the interest.


Paying down that $60K loan is a risk-free 6.8% return, tax-free. You should be doing that even before making unmatched contributions to a 401(k) or IRA, never mind making a high-risk taxable investment; your risk-free investments in those funds are earning a lot less than 6.8%.
David Grabiner

inv321
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Post by inv321 » Sun May 16, 2010 10:36 am

I would strongly favor paying off the 6.8% loan.

I have dealt with multiple rental houses and in my opinion you will be lucky if all that you LOSE is 6.8%. Plus, there are always numerous issues with owning properties which makes them a big hassle - both in terms of time and money. It is never as simple as "oh, we will just buy this good little property and get some renters in there".

Paying off your debt is a hassle free guaranteed 6.8%. If I could find that guaranteed rate of return I would jump all over it. I personally would even pay off the lower interest rate loans before venturing into something such as investement properties.

marco100
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Post by marco100 » Sun May 16, 2010 10:59 am

I've been presented with an investment opportunity that may not come our way again for a long time.


Truly great investment opportunities, in this case rental real estate, do not magically fall into one's lap.

Finding them takes a lot of hard work and knowledge.

You're talking about a single family rental house, right?

What makes this one so special?


The mere fact that you are contemplating the possibility that you may have to pay the mortgage on a vacant rental property means it can't possibly be such a great opportunity.

You have no experience as a real estate investor nor as a landlord.


If "someone" has supposedly presented you with the "deal of a lifetime," then you have to ask yourself: 1. Why? and 2. Why ME?


Normally you only will get a really great deal on rental real estate if for some reason the seller is extremely distressed and needs to sell quickly for personal reasons, i.e. say a divorce. Then as a real estate investor you need to be able to bring cash to the table to close the distress sale as quickly as possible. You're talking about taking out a mortgage on the property, non-owner occupied means you will have to put AT LEAST 30% down on the property.


Also, what happens if you decide to start having children and your wife quits working for a few years to raise them. (It happens. A LOT!)


You should make your calculations based upon being a single income family only, i.e. only your income.

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Abciximab
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Post by Abciximab » Sun May 16, 2010 12:49 pm

Thank you to everyone that responded. My wife and I discussed our options last night, and we were pretty sure it would be better to pay down our loans. Now, after reading all the comments here, we know that is the right course of action for us. We are very grateful to those of you who offered your time and advice. Thanks again.
An investment in knowledge always pays the best interest - Benjamin Franklin

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