Ah, the age-old question. To pay down debt or invest for even bigger payouts? It’s a dilemma that I myself have been in, along with countless other investors. There are good and bad things about both strategies, and it can be a difficult decision to make, especially if you would need to add to your debt in order to invest (i.e., take out a mortgage to buy a rental property).
Here are my thoughts on the matter.
Let’s talk about debt first. For most people, this is a bad word. Debt means you owe someone else money, and being in this position is no fun. But debt is a bit more complex than just owing someone money. There are different kinds of debt, and some are riskier than others. Think about the high stakes that come with payday or title loans, where you get a few hundred bucks upfront, but you pay through the nose in interest. That’s one kind of debt. Now think about this type of debt: a low-interest mortgage, where instead of a few hundred dollars, the prize is real property, which can actually make you money over time.
See how debt can be different?
Now let’s talk about rental property for a minute. For the majority of people, owning rental property is a positive thing. It provides extra monthly income (cash flow), and when you’re ready to sell it, you make money because the value has increased since you bought it (appreciation). But to own rental property, you’ve got to lay some money out front, and it can be expensive.
You have two options when buying new property. 1) You can pay for it in full as a cash buyer, or 2) You can take out a mortgage, where you put a percentage down and then make payments to your lender, including interest.
Let’s say you’re in a position where you want to buy rental property to take advantage of that sweet cash flow and future appreciation payouts, and you have $10,000 saved up. It’s not enough to buy a property all-cash, but it is enough for a down payment. But here’s the thing: you also have some debt. You’ve got a credit card ($3,000) and maybe some school loans ($5,000). Both of these have interest rates that are costing you a lot of money each month.
So are you better off putting that savings toward your debt, or using it as a down payment for a rental property? It’s a tough question, because it all depends on your debt to savings ratio. Using the example above, my recommendation would be to use the $10,000 to buy a cash-flowing rental property, and use the added income from that to pay down your credit card and school loans even faster. If you decide to use the savings to pay off your debt instead, you’re left with just $2,000 in the bank; not enough for a down payment and you’ll spend the next several months saving to get that figure up again. Granted, you won’t have those pesky credit card and school loan bills, so you can save a bit faster.
Really though, it comes down to a few factors. Your precise financial situation (debt ratio, interest rates, savings, etc.), comfort level with risk (more debt equals more risk), and your credibility in the eyes of a lender (can you even qualify for a mortgage?). Personally, I am comfortable taking on a bit of risk if I’m confident the payout will be there. I choose my properties wisely. I do lots of research on them and the larger market, and I listen to what the numbers are saying. If they don’t add up, I don’t buy.
To summarize, there’s not a clear answer to this question. It’s not a black and white situation, and there are just too many variables that make each investor’s situation unique. I will say this, though. If you have a lender willing to give you a mortgage, and you have found a quality, cash-flowing property, and you’re not putting yourself in a big financial strain, then it makes sense to buy the property and add to your income and overall assets.
But hey, I’m an investor. What’d you expect me to say?