Can you invest in real estate when you have debt? The short answer is “maybe.”
Think of debts in 3 distinct categories:
- Good debts: These are debts that have low interest rates and allow you to buy assets that will increase in value. Mortgages are the main example.
- OK debts: These debts have relatively low interest rates and are used to buy things you need. Auto loans and student loans are OK debts.
- Bad debts: These debts have relatively high interest rates, like credit cards and some personal loans.
Should You Invest in Real Estate While in Debt?
It is generally okay to invest if you have “good debt”. For example, mortgages are so cheap (interest-wise) and you can reasonably expect to earn more from investments, so it’s typically a smart idea to pay what you have to, but invest the rest. In other words, if you have the choice between paying an additional $500 toward your mortgage or using it to contribute to the IRA, it’s tough to make a case against investing the money — at least from a mathematical standpoint.
When it comes to the “OK” debts, it depends on the situation and your personal comfort level with debt. As an example, if you’re paying 5% interest on your car loan and have enough to pay it off in full, should you invest the money or use it to get rid of the car loan? There’s a solid case to be made either way: It’s nice to own your car (a depreciating asset) free and clear, but at the same time, you can reasonably expect to earn long-term annualized returns greater than 5% from investing. If paying the loan off gives you peace of mind, there’s nothing wrong with it.
The last category of debt is where it’s a no-brainer. Investment properties can be reasonably expected to produce yearly total returns (income plus appreciation) in the 10% to 15% ballpark. Meanwhile, the average credit card interest rate is about 16.4%. So, by investing instead of paying off that debt, you’re literally setting yourself up to lose money.
If you have a credit card or other high-interest debt, it may be difficult to justify investing any money until it’s paid off. On the other hand, if you have a mortgage, auto loan, or student loan debt, assuming you can comfortably afford your payments and aren’t constantly stressed out about the amount of debt you have, it can still make good financial sense to invest in real estate.