Q. My spouse and I are interested in buying a home. However, we’re terrified to spend so much on one single item. What should we know before taking the plunge?
Explore This IssueACEP Now: Vol 34 – No 10 – October 2015
A. I am continually fascinated by the burning desire among graduating medical students and even residents, and particularly their spouses, to purchase a home as soon as is humanly possible despite having a net worth of a negative $200,000 or $300,000. For many people, owning their home is a signal to themselves and others that they have finally “made it.” Combine that signal with heavy marketing from the realty and mortgage industries, and we see far too many doctors purchasing the wrong house at the wrong time and at the wrong price. Although it is certainly possible to get lucky, there are several important financial principles doctors should understand in order to buy their home properly.
There are lots of great reasons to own your own home, including the fact that you can have as many pets as you like, you can paint the walls whatever color you prefer, and the landlord can never throw you out on the street. Financially speaking, there are many significant benefits of owning a home. You avoid paying rent, you get to keep any price appreciation, and mortgage interest and taxes are usually fully deductible. Most mortgage payments are fixed, so as the years go by, the mortgage actually gets cheaper and cheaper on an after-inflation basis rather than increasing with inflation as rent generally does. For most people, a paid-off home reduces required minimum monthly income dramatically, which further reduces the need for disability insurance, life insurance, and a larger portfolio nest egg.
However, there are time periods in life when owning your home is a not such a great financial move. As a general rule, it does not make sense to purchase a home if you will not be in it for at least five years. However, during a housing boom, you may break even in less time, but in a housing bust, it may take two or three times that for your home to return to its purchase price, much less break even on the deal. Rookie home buyers nearly always underestimate the non-mortgage expenses of owning a home. These include the transaction costs of buying and selling (expect a round-trip cost of 15 percent of the value of the home), maintenance costs (1 percent to 4 percent of the value of the home each year), insurance, taxes, upgrades, furnishings, landscaping, lawn care, snow removal, and homeowner’s association fees.
Is a Home a Good Deal for You?
Too often, prospective first-time home buyers believe real estate agents who advise buying because “the mortgage is less than your rent” or “you don’t want to keep throwing money away, do you?” What rookie buyers don’t know, however, is well-known by real estate investors. The mortgage is supposed to not only be lower than the rent but dramatically lower. That’s because the landlord has to pay all those other expenses. A real estate investor expects about 45 percent of gross rent to go toward non-mortgage expenses. In order to compare apples to apples, multiply your prospective principal and interest payment on a 30-year mortgage by 1.8. If renting a comparable home is much less than that figure, there is a very good chance you will be better off renting unless you are in the home for a very long time.
Even when purchasing a home makes sense, it is critical to realize that a home purchase is mostly a consumption item, not an investment.
Given these and other economic realities, it generally does not make sense for an EM resident to purchase a home. If you think you are an exception, run the numbers using The New York Times’ “Is It Better to Rent or Buy?” calculator found at www.nytimes.com and see just how much appreciation you will have to realize just to break even, much less come out ahead. In fact, most attendings would do far better renting for six to 12 months out of residency. This allows physicians to stabilize their finances, make sure the job is working out, and provide a much more thoughtful and deliberate housing search, all enabling a much stronger negotiating position.
Be a Savvy Home Buyer
Rookie home buyers usually don’t realize how good their negotiating position is. There are usually dozens of similar homes on the market at any given time, but home sellers are lucky if they can get even two interested buyers simultaneously. While there are occasional seller’s markets, home buyers should understand that 95 percent of the time it’s a buyer’s market. If you can avoid falling in love with a house, you may be surprised just how good of a deal you can get on a perfectly acceptable house.
Even when purchasing a home makes sense, it is critical to realize that a home purchase is mostly a consumption item, not an investment. Larger homes require more money to heat, cool, maintain, furnish, landscape, insure, upgrade, and clean. Try to buy a home closer to what you truly need rather than everything you could possibly want. Although a mortgage lender may approve you for a home costing four to five times your gross salary, you would do well to make sure your mortgage is less than two times your gross income. So if you make $250,000, the general rule is that your loan amount should be less than $500,000.
In recent years, many lenders have started offering “physician mortgage loans.” These are loans that banks will give to a physician that allow them to avoid private mortgage insurance (PMI). PMI protects the lender against you defaulting without your putting down a standard 20 percent payment. These loans usually also offer special underwriting that will allow you to close with just a contract rather than proven earnings and may take your student loans into special consideration. It is important to realize that these lenders aren’t doing you a favor out of the goodness of their hearts. These loans have slightly higher fees and interest rates than comparable conventional mortgages. The banks are also well aware that your risk of default is very low and hope you will then use their bank for your banking, investment, and insurance needs. A physician loan can make sense but only if you are using the money you would have used for a down payment for a better financial purpose, such as paying off high-interest student loans or making retirement account contributions. If you aren’t already using 15–25 percent of your attending gross salary to build wealth (ie, saving or paying off debt), then purchasing a home, with or without a physician mortgage loan, probably isn’t a great idea until you get your financial house in order.