If you’re in debt, its hard to make long term plans for wealth and retirement because they seem so far away. I’m in this position where I know all the right things to do to build wealth but I can’t actually act on them because I’m still deep in the hole and need to climb out. The pursuit of financial independence starts from zero. I’m way in the negatives feeling my way through a dark and at times depressing journey to net positive, the point where my debts are eliminated. At this stage of indebtedness, making progress requires me to make more money and put it all towards my student loans until they are completely eliminated. So I find myself having to break the rules for achieving financial independence to first achieve freedom from debt.
My debts are prioritized as:
- Credit cards
- Student Loans
- All other debt including mortgage
In the next few months, I will eliminate my remaining credit card debt and be able to focus on the second and most challenging liability I have, my student loans. Paying off over $150K in 3 years requires making payments of at least $5,000 a month for the next 24-36 months. Coming up with this kind of money is going to require some bold moves on my part. I need to find streams of income that can produce that much after they cover my expenses. For now, the only such stream of income I can think of aside from my salary is real estate. With real estate, I can create a positive cash flow that will allow me to tackle my student loans aggressively. So I’ve decided to purchase another property and rent it out. All the profits from the rental property, my salary as well as my side hustles will have to be able to generate at least $5,000 a month. But real estate is cash intensive and requires a large upfront investment. So unfortunately I’ve had to make a few sacrifices that I wouldn’t even have considered if I didn’t have student loans. But alas, since I don’t have wads of cash lying around, I took out my Roth IRA to use it as a down payment on my property purchase. My account is now a sad shell of what it used to be :(. My goal is to replenish it once I’ve tackled a few high interest installments. I guess I’ll have to lose out on the compounding effect until that time.
Having to withdraw my Roth IRA to buy a property has me bummed. But I’ve made peace with it. After all, a rental property will help me eliminate my loans. And once my loans are gone, it will become a source of passive income. I’ll be looking for properties to purchase and hopefully making an offer in the near future. Once I’ve purchased a property and done a quick live in renovation, I will rent it out and begin my debt repayment journey. Here’s the plan:
- 0-2 month: Purchase property and make cosmetic changes
- 2-4 months: Rent out property and start to tackle consumer debt
- 4-6 months: Implement student loan method 1, transfer the first student loan balance to my zero interest credit card and start paying it off.
That’s the plan. I’ll be doing my best to stick to it. Here we go…
Cash out Refinance: This is also another method people might consider risky. Why use the equity you’ve accumulated to pay off debt instead of reinvesting it? Why reverse the progress you’ve made on paying off your mortgage? Consider this:
The condo the mortgage is associated with a property that can appreciate in value while a student loan can only be a liability and digs me further into debt the longer its around. While its not a guarantee that properties will increase in value, they do have the potential to do so. Debt, cannot appreciate in value or benefit you in any way by hanging around longer. Between 2015 and now the value of my home has increased by $20,000 creating a significant amount of equity. In the same amount of time, the loan I had taken out to pay the cost of tuition has accrued close to $10,000 in interest. One is providing me with equity, the other is dragging me down into the abyss. Even though I have no guarantee that the value of my home will continue to rise, I would rather take my chances with it than continue to sink faster and further into debt.
Mortgages have a longer term and a lower interest rate. While student loans are generally given a 10 year period to be paid off, Mortgages come with 15 and 30 year terms meaning that you have more time to pay them off. In addition, on average, mortgage interest rates are lower than student loan interest rates. At least in my case, my mortgage has an interest rate of 4.125% for a 30 year term wile my student loan average is around 6.3%. In addition, the interest on mortgages compound monthly while the interest rates on student loans compound daily. This means that the cost associated with the interest rate for mortgages increases monthly while the cost associated with the interest rate on my student loan increases daily.
Student loans are not forgivable essentially under any circumstances, even death while mortgages are. Mortgages are backed by the house as collateral. This means that the house could be sold to pay back the mortgage and if there is any debt that remains, it will be forgiven. This option is not available for student loans. Even if you file bankruptcy, you cannot get rid of student loans and must find a way to pay them off. By using this method to reduce my student loans, II would be reducing the amount of debt I would have remaining in the event of a bankruptcy and making it less likely that I would have any debt remaining.
I do believe in investing. Under any other circumstances I would opt to invest any equity I take out instead of paying my debt. But student loans are the type of debt you should tackle as soon as you can because they’re literally the worst kind to have.
Fortunately for me, there have also been changes in the refi laws that favor people who want to use this strategy. Secondary mortgage buyers like Fannie Mae and Freddie Mac are willing to reduce/get rid of the fees associated with cash out refinancing provided that you’re taking the money out to pay off your student loans. They work with companies like SoFi to make these options available. You can also take out a larger percentage of your equity for this reason than you can for reasons like home improvement etc. I’m now quietly waiting for my equity to accumulate and in a couple of years, all else being equal; I will be able to use it for this purpose. My goal is to use this strategy to finish of the loans I will have remaining towards the end.