It’s Passive Income MD’s turn for a Saturday Selection. Today, we will learn how the anesthesiologist tackles his student loans with a passive income stream.
Some people like to pay down debt as soon as possible; others like to hang on to low-interest loans indefinitely. I made it a goal to be debt-free by forty, but I did carry my student loans for quite some time after I had the money to pay it off.
Let’s see the approach taken by PIMD. As always, this article first appeared on Passive Income MD.
Paying Off Student Loans With Passive Income
As physicians, we’ve all felt the crushing weight of the almighty student loan. Some have felt it more than others, perhaps, but a vast majority of medical school graduates wonder if they’ll ever pay their loans off. In fact, according to the AAMC, the average medical student leaves school with about $190,000 in student loan debt. That can be a very intimidating number.
Looking back at my own post-med school debt, I can safely say that I was very fortunate. Why?
● I left medical school with just under $95,000 in student loans that are now less than $85,000.
● I went to my state school where my first-year tuition was only $13,000. Of course, it nearly doubled by the time I finished school, but overall I feel it was quite affordable.
● I graduated at a time when I could consolidate the loan for under 3% for 25 years
After a few years out in the real world, and after buying my house, I found myself in a pretty comfortable situation. I had saved enough money to actually pay my student loans off completely. But did I do that? Nope.
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Not All Debt is Bad
See, in my mind, all debt isn’t necessarily all bad. Debt for an education is usually good debt. Taking out a loan for a fancy car and struggling to make payments each month is bad debt. Debt that you can use to make money (cash flow in excess of the interest you’re paying on the debt)… well, that’s very good debt.
So, instead of paying off my student loans all at once, I decided to take that money and buy a rental property. In a future post I’ll go deeper into the buying process, but for the purpose of this article, I’ll cut to the chase: I ended up paying a little less than $35,000 to buy a single-family home at a purchase price of $105,000. I rent this property out and receive a cash flow of $475 per month.
Can you guess what my current loan payment is? $460.46.
So as a result, the cash flow from my rental is covering my entire student loan payment every single month. My initial $35,000 is secured to the property as equity, the tenant is paying off the rest of the loan on the home, and I’m gaining further equity in the home. The average appreciation rate in that area is 2.37%, so I’m actually gaining value in the home as we speak.
The rest of the 19 years on this loan could be paid off by my tenants, while the property appreciates in value and gains in equity. Additionally, when that home is fully paid off, there will likely be a jump in cash flow, and the value of the property should be decently higher.
So, What’s the End Result?
My $85,000 loan will be paid entirely by a $35,000 investment in a home. Eventually, that $35,000 will be worth at the very least $105,000 (the purchase price of the home), plus any appreciation that will have taken place and minus any large repair expenses. What happened to the $50,000 I didn’t use? That went into a down payment for an apartment building I bought with a partner, but that’s a post for another day.
With all that said, I certainly can’t fault anyone for choosing to pay off their debt all at once. There is value to the peace of mind that comes from knowing you are debt-free.
However, I place a much larger value on building my path to retirement. I can stomach the debt as long as I know it’s being paid off by my tenants. When it comes right down to it, I can rest easy, because my student loans are being paid off completely by passive income.
If you’re trying to figure out what to do with your student loans, be sure to visit my Student Loan Resource Page.
Anyone else have an outside-the-box method to pay off your student loans?
22 thoughts on “Paying Off Student Loans With Passive Income”
What’s the risk if you burn the house down? What’s the risk of a tornado?
Do you think 4% withdrawal rate in retirement is safe?
The reason I ran it through FIREcalc was to understand the market risk. Everybody and their brother uses this tool to understand when it’s “safe” to retire based on history. The risk I proposed was 1 failure out of 99. I have twice as much in post tax equities as I do in pretax accounts. I don’t have much trouble making the portfolio tax efficient.
I ran an anesthesia group for 18 years, it was great till the hospital went total “Team Health” and we lost the contract… What risk does that pose?
This post reveals an excellent strategy.
You could likewise do this by buying stocks if your not into real estate, for example if you change jobs you might want portability.
An alternative passive income strategy: Simply put the dough into a mutual fund and withdraw the $460 every month or $5520 at the end of every year. I Firecalc’d the scenario and it was 12 years before taking away $5520 per year from $85K invested had 1 failure, so that is your risk. The mean value of your account at 12 years would be $73,000 with a max projection of 173,000. After 12 years you would have 18,000 left on your loan, so just pay off the remaining and pocket something around $55K to $150K. You don’t have to worry about a new roof, new AC, vandalism, paying taxes, vacancy , the risk of having to move out of town and hire a manager, the neighborhood going bad etc etc This passive strategy is portable.
In the mean time you’re free to invest your income as aggressively as you like.
Another interesting take.
Two issues that come to mind with using stocks in this situation:
1) Market risk. A bear could ruin your plan. This is also a risk with real estate (PIMD took a liberty in my opinion by saying his property would be worth at a minimum $105k – there is no way to know this will be the case.)
2) I’m no expert on this but I believe tax efficiency would be much worse investing in the stocks.
Great post, PIMD! Agreed that all debt is different. What you have done is very innovative…taken a lump sum, invest to obtain net passive income after all operating costs, and pay off student loan debt. I might have missed it in the article, but where did you get the intial $35k?
Thanks Vivek. That’s just money I’ve saved up. As a partner in my group, I’m given a profit-sharing bonus at the end of the year. I don’t rely on this bonus, so it’s a nice surprise that can go towards paying down debt or investing. Don’t remember if this directly came from that.
I couldn’t agree more with this post! Not all debt is bad debt. Hardly anyone agrees with me when I tell them that. Nor do they agree with me when I say you don’t have to pay your debt off ASAP.
Sounds pretty lucky to only graduate school with $95K in debt. I’m only in my 2nd semester and have $72K in student loans…with a 7% APR on those suckers… ugh…
I actually never thought of paying off debt via passive income that is a great idea. And as the house appreciates at roughly 2.37% and your student loans are 3% sounds like you won’t be too far behind all that compounding interest that is accruing on your loans.
Sure you will have to pay for all the “hiccups” but it seems like you will end up ontop.
I like this idea and can’t wait to get my foot into rental properties.
Like they say, it’s better to be lucky than good. I came out at a great time for student loan interest rates. In fact, my loans are now below 2%, so I’ve tried to do anything but pay them off early. Considering inflation, considering local appreciation and all the benefits from owning real estate, I think I’ll come out way ahead using this method.
If their rent is covering your student loan payment, then aren’t you still paying the mortgage each month? Do the tax benefits make that a wash?
Cashflow is calculated after expenses, including mortgage payments, have been covered.
He owns the property there is no mortgage
Could you mention how you mitigate the risk of not having a tenant?
I see the risk with this strategy is instead of your tenant paying off your loan, if you don’t have a tenant you now have 2x bills.
I like the strategy idea and if I had the capital to purchase the property as you have, it would definitely be something to consider! Passive income and debt off all in one 😀
In reality, I do take a small reserve every month for maintenance. Vacancy I factor at 8%. That’s the risk with a single family home, one person moves out, 100% of your income is gone. So it should definitely be taken into account. At some point, if the property’s equity has grown to equal the balance of the loan (and factor in transaction costs), I guess I could sell it and pay off the loan as well.
It sounds like this could be a great addition to the article for those who are interested in the strategy because the risk is a huge part of the decision.
Thanks again for sharing!
I’m not sure why it’s 2x the bill? He owns the property so if it’s empty, it’s just empty and he just pays the loan. There is an overhead to owning a rental but it’s certainly less than his rent and the property continues to appreciate.
I would not call this debt I would call this leverage
It is using debt as leverage, but still debt.
I was saying he now has 2 bills, not just one – so we’re on the same page on this one :).
I don’t doubt that real estate can be used this way but it’s a little disingenuous to assume that you’ll go 19 years without significant repairs or maintenance costs, never have a tenant who defaults on rent and the property will never sit empty. These things plus transaction costs are likely to reduce the passive income.
The people I know who bought investment property on the side all dealt with some combination of the above factors.
These came to my mind as well – maybe he’s done something to mitigate these risk such as putting some money off in an emergency fund?
I’m not sure but definitely agree with the points!
You’re absolutely right about other unforeseen costs being a possibility. I do take a small reserve every month. On the flip side, the rent ideally continues to increase as well and I’ve seen that be the case in the couple years I’ve owned the property. I also didn’t factor in taxes, appreciation & principle paydown but those are also other “returns” that should be considered when investing in real estate. Hopefully it just got you thinking about different ways to attack debt.
I’ve thought about doing something similar as far as setting up passive income to pay off my student loan debt. My problem just comes from having the capital on hand to purchase something such as a rental property.
One other thing to think about or at least mention is that by delaying paying that off for the next 19 years that 3% compounding interest is going to cost you about $30,000.
You’re obviously still likely to come out ahead given the money being made at the rental property, but a part of the decision no less.
Thought provoking post for sure. Take home is to be thoughtful and intentional about how we pay down out debt! Not coming up with a plan at all is the worst thing that can be done (or not done).
I agree, having a plan is the most important thing. It’s different for everyone depending on you particular situation, risk tolerance, mindset, etc.
I wrote on this topic this week too. In my research I found a recent study that shows 36% of Americans think they’ll NEVER pay off their student loans. That’s disturbing, and a bit sad. There are a number of “tricks” and tips that can be used to pay off student loans faster – including passive income as mentioned here. People really should take it more seriously and get it knocked out.