Someone once asked us, should you invest in real estate or pay off your student loans? Many people who have student loans wonder whether they should focus on repaying their student loans or use any additional money to invest. One type of investment that often comes up is real estate. That’s partly because many people dream of owning their own home or of buying investment properties to rent out in order to generate income.
But does it make sense to do this before being debt-free?
Investing vs. Repaying Student Loans
Most financial advisors will tell you it doesn’t make sense to wait to until you’ve repaid your student loans. That’s because student loans generally charge a relatively low-interest rate while many types of investments provide greater returns than that.
Here is an example. If your student loan is charging 5% interest, but you can make 7% by investing in the stock market – then it makes more sense to repay your student loans slowly and invest any additional funds in the stock market or another investment opportunity.
Is Real Estate a Good Investment?
Real estate is an investment that has the potential to offer great returns. How big those returns will be, depend on the market you’re buying into and the purpose of your investment. If the real estate market is growing in value at a rate greater than the interest charged on your student loans, than investing in real estate makes sense. Unfortunately, real estate is cyclical and so it’s hard to know whether that growth will continue.
If you plan to live in the home that you’re buying, such as a duplex, your return could be greater. The money that you would otherwise have been putting towards rent would now go to your mortgage. This would reduce the real cost of your investment and the equity you build would mean that your return will be better.
But when you’re investing in real estate, there are a number of other costs involved which could reduce your return. For example, you’ll have to pay taxes, buy insurance, and cover repairs on the house. Each of these expenses will increase your cost. That means even with a 5% price increase on your property annually, the actual return on your investment is less.
One of the safest approaches to this technique is to buy strictly relying on the cash flow the rental property will generate. This way if the home value fluctuates, you will still be able to pay for all your expenses and weather the market changes. The real estate market will vary greatly depending on which part of the country you live in.
It is critical that you do your due diligence and run the numbers to ensure your rental property is generating positive cash flow at the end of each month. This will pay great dividends later on. The more times you run the numbers, the better you will be at understanding your local real estate market.
Ultimately, the only way you will really know if you should buy real estate or pay off your student loans is to run scenarios. Use our free Student Loan Vs Rental Property Analysis tool by clicking on the image below or using the menu by clicking the Tools -> AssetRover Downloads link, to help you decide which scenario makes the most sense for you.
Fees and Interest Rates
Another important factor to take into account is how long you plan to hold the investment. Unlike stocks, it is sometimes difficult to sell real estate investments quickly. There are also high costs involved in buying and selling real estate such as agent fees, taxes, and closing fees. If you don’t plan to keep the property for a long time, then those fees could eat into your returns.
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If you have a high-interest rate on your student loans, it could also make it more difficult to make enough by investing in real estate. Should that be the case, you should think about refinancing at a lower rate. This could save you thousands of dollars and make it more beneficial to invest rather than repay your loans.
The Bottom Line
Many people who have student loans want to repay their debt as soon as possible. But if you wait and repay your student loans before investing, you lose valuable time that could be used to grow your net worth. In the end, you need to take your time, and do your analysis to make sure you are making the right decision to invest in real estate or to pay off your student loan.