Prior to investing in real estate, nearly every entrepreneur asks themselves at least one variation of a relatively simple question: Should I pay off debt or invest in real estate?
Not surprisingly, most people assume it’s better to start off their real estate investing endeavors with a clean slate; one that’s not complicated by messy debt obligations. For good reason, it’s reasonable to assume that starting out your investing career debt free is the way to go, but I digress. The answer isn’t that simple. There are several things you need to take into consideration before you decide to pay off debt or invest in your future.
I want to stress one thing: there’s no universal answer to whether or not you should pay off your debt immediately or invest. Each person’s financial situation is different, and you are no exception. Before you make a conscious decision to pay off your debts or not, consult a financial advisor to determine the right path for you. That said, there’s a lot of data to suggest that it may be more beneficial to retain good debt, and invest the capital you have on hand in a tangible asset like real estate.
While it may make plenty of sense to pay off your debts before investing, consider one thing: liquidity. If you do decide to pay off your debt obligations, you will hamper your ability to remain financially liquid; you won’t have as much access to money as you previously had. Of course, your debts will be paid, but you will also have little to no money left over. Conversely, if you choose to invest your money instead of paying off your debt, you could potentially make more to cover the original debt, and then some. Allocated wisely, the $100,000 you invest in real estate (and didn’t pay down your mortgage with) could net a nice profit; one that could have never been realized if the money was spent paying off debt.
If for nothing else, paying off debt restricts what you are able to do with your own money. Therefore, I would argue that retaining good debt isn’t a bad idea. The liquidity you maintain by remaining in debt could go a long way in a good investment. That is, of course if you invest wisely.
[ Starting a real estate investing business? Be sure to follow “The Ultimate 2-Person Team” blueprint ]
As I already alluded to, there’s no real issue with retaining what I like to call “good” debt. The money you keep can be invested, and perhaps even make you more than you started with. There are times when paying off debt can be beneficial. Bad debt, for example, does nothing to further your financial standing, and instead detracts from it until it’s paid off. Therefore, it may be in your best interest to pay off the debt that can’t be leveraged into making more money. Credit cards with high interest rates are the perfect example, as they do nothing to add to your wealth building strategy and, instead, detract from it.
Prior to deciding whether or not to pay off your debt, you must first determine which type of debt you currently carry. If you are like most Americans, there’s a good chance you have both good and bad debt.
Not all debt is created equal; that I am certain of. There is an inherent difference between high-interest debt that does nothing to further your own financial gain and low-interest debt that can be leveraged into an opportunity to make more money. More specifically, however, some forms of debt are better than others.
I could easily argue that a mortgage constitutes what I like to call “good” debt; while it may reflect a negative balance in your checkbook, years of payments will help homeowners build up an equitable interest in the property. So while you may have large debt obligations each month, the money is ultimately contributing to your long-term financial well-being. After all, it’s true what they say: you have to spend money to make money. But then, of course, there’s bad debt, or high-interest loans that don’t allow you to leverage money in a way that will help you build financial wealth. Credit card debt accumulated from shopping sprees and material possessions, for example, is nothing more than a vice, and a quick way to drain your savings account.
Again, not all debt can be lumped into the same category, which begs the question: Should I pay off debt or invest in real estate? Fortunately, the answer is relatively simple, but it first requires each individual to evaluate their own circumstances. Differentiating between the two types of debt will help determine whether or not you should pay off your debt or use the capital you have on hand to invest in real estate.
Those interested in investing their money need a good reason to do so. If for nothing else, not all investments are created equal — just like the debts we have already discussed. Not surprisingly, there are both good and bad investments. If you are looking to allocate the money you are debating to spend on debt into an investment, make sure it’s a good investment; namely, that the reward is worth the risk.
Come Up With A Budget: The fastest and simplest way to rid yourself of debt is to stop accumulating it. Unfortunately, debt has become almost necessary in today’s society; eliminating it altogether isn’t possible for some people, but everyone can limit the amount of debt they take on. More specifically, draft a budget to help you manage your expenses. The less debt you accumulate, the easier it will be to pay off what you already owe.
Target High Interest Rates: Provided you have chosen to pay off your debt, make sure you are paying off the right debt first. Credit cards, for example, are almost always a good place to start. Take a look at which credit card has the highest interest rate and pay that one down first. High interest cards should be dealt with first, as to prevent them from piling up even more debt.
Consolidate: Ideally, those with good credit might be able to consolidate their debt into one payment with a lower interest rate. Debt consolidation can make things easier and less expensive the long run, but not everyone qualifies.
There are arguments to be made for either decision you choose; it wouldn’t be much of a debate if there weren’t. There is absolutely no reason one person couldn’t be better served paying off their debt before investing in real estate. On the other hand, there are plenty of people that would be better off remaining liquid with their finances and investing them in real estate. Only one thing is for certain: the decision you choose will be entirely defendant on your personal circumstances. To help you make a better choice, however, here are the pros you can expect from each side:
The pros of paying off debt are painfully obvious. First and foremost, paying off debt will alleviate what many people consider to be a financial burden. Debt is, after all, an obligation that must be paid. Not only that, but debt is an obligation that gets more expensive the longer you hold onto it, so it’s important to rid yourself of it in a timely manner. Paying off your debt will, therefore, help you avoid compiling interest and actually save you money over the long haul. On top of that, paying down your debt can improve your debt-to-income ratio, an indicator that heavily influences your credit score and how lenders view your own credit worthiness.
If you don’t choose to pay down your debt and, instead, choose to invest it in real estate, there are significant benefits to be had. First off, not using the money you have on hand to pay down debt helps you maintain a certain level of liquidity. The money can then be used to invest in real estate, which has become synonymous with countless benefits, not the least of which include:
The pros of investing in real estate are vast, and the path you choose could alter which ones you benefit from. Each exit strategy comes with its own set of pros, and cons for that matter. However, done correctly, investing real estate can be a great move.
If you still don’t know whether you should pay off debt or invest in real estate, don’t worry; you are not alone. For one reason or another, most people with a little debt and a desire to invest struggle with the same question, and rightfully so: it’s a legitimate question. Everyone’s answer won’t be the same, as there’s no universal remedy. What works best for some may not work at all for others. The key is to look at your own financial situation and make your decision accordingly. That said, there is a great argument to be made in favor of retaining debt and using the money you have on hand to invest in real estate.