By Dr. James M. Dahle, WCI Founder
There is a very strange phenomenon I've noticed amongst 4th-year medical students. They have this seemingly overwhelming desire to buy a house. I'm not sure if its the delayed gratification thing rearing its ugly head, or if it is some unwritten rule that once you own a house “you've made it.” While everyone's situation is different, and rules of thumb aren't necessarily helpful, most residents probably shouldn't buy a house.
I wish my crystal ball had been working properly back when I was a new resident renting in Arizona during the housing bubble. If I would have bought when I first arrived and sold just as I finished residency before the market burst, I could have made out very well. Some of my classmates doubled their money in 3 years. It didn't work out so well, however, for the new interns buying houses when my classmates were selling and they obviously took a shellacking when the bubble burst.
10 Reasons Why New Interns Should Curb Their Housing Fever
#1 You Don't Have a Down Payment
There are five benefits to using a down payment.
Market Swing Protection
Using a down payment protects you from swings in housing prices. It costs approximately 10% of the value of a house to sell a house (6% commission, 1-2% to fix it up and 2-3% due to the house sitting empty for a couple of months.) If you put 20% down, the value of the house can drop 10% or so before you're underwater. Many people are stuck living in or renting out their homes because they literally cannot afford to sell it. You don't want to be in that situation.
Better Rates and More Options
The more money you put down, the more loan options and better interest rates you are offered. There are, of course, many lenders who do “Doctors Loans,” requiring little to no down payment, but just because someone is willing to lend you money without a down payment and without verifiable income (aside from a contract) doesn't mean that loan is actually a good deal for you.
Avoid Private Mortgage Insurance
A 20% down payment allows you to avoid private mortgage insurance (PMI) on conventional mortgages (PMI isn't required on Physician Mortgages). PMI doesn't even help you — it's insurance your lender makes you buy to protect THEM.
Avoid Jumbo Loan Rates
You may be able to avoid a higher rate “jumbo” loan by putting more money down.
Smaller Mortgage Payment
The more you put down, the smaller the principal and thus the smaller the mortgage payments, improving your future cash flow.
#2 You Don't Have Any Income
Traditionally, no one would loan you money until you had a steady job. If you're applying for a loan in April of your last year of med school, you're unable to show any income. If you were a lender, who would you offer a better deal to — someone with several months of steady income or someone who hasn't made anything in years?
Again, this constrains your loan options, and the fewer options you have, typically, the more expensive your options will be. “Doctors loans” are generally your only option, and depending on your state, you may only have a handful of lenders to choose from.
#3 You Have Tons of Debt Already
It is no longer uncommon for a graduating medical student to have $250K or more in relatively high-interest student loans. Residents usually already require a special government program like IBR to help lower their payments during residency. It really isn't a great time to be adding on even more debt, not to mention it is harder to get a loan with tons of debt hanging over your head, narrowing your choices to just “Doctor Loans.”
#4 Residency Is Only 3-5 Years Long
Even realtors, the most diehard advocates for purchasing a home early and often, admit that it's hard to break even on a home unless you're in it for at least 3 years. The main reason for this is transaction costs. Expect to spend 5% of the value of a home when you buy it, and another 10% when you sell it. This includes closing costs, the cost of fixing it up, furnishing it, realtor commissions, and a couple of months of the house sitting empty while you're selling it. In order to make up for that 15 % in transaction costs, you'll need to pay down the loan and the house will need to appreciate.
On a typical 30 year mortgage (4% fixed) bought with 0% down, you'll pay down 5.5% of the mortgage in 3 years (9.5% in 5 years.) That means you need the home to appreciate about 3% a year during residency just to break even. If it doesn't appreciate, or worse, goes down, you're going to lose money.
Even if everything works out, and you spend 5 years in the home and it appreciates 3% a year, you're looking at a gain of only 9.5% of the value of the home. That's $14K on a $150K house and assumes that your monthly costs for principal, interest, taxes, insurance, and maintenance are equal to what the equivalent rent would be. That's hardly a huge sum of money worthy of all the risks and hassle you went through for 5 years.
#5 You Can Rent a House
I always hear about how people are sick of living in an apartment and delaying gratification for their entire 20s. People don't seem to realize that you can usually rent a house that is just as nice as the one you can buy. Your choice isn't between renting a tiny apartment and buying a big house. Your choice is between renting the house you want to live in and buying the house you want to live in.
#6 New Home Buyers Underestimate the Costs of Ownership
Houses are expensive consumer items, not an investment. When the furnace or dishwasher breaks, you can't just call the landlord to replace it. Roofs, windows, flooring, carpet, and paint only last so long. New buyers are also often surprised by the cost of property taxes and homeowners insurance, not to mention special hazard insurance like flood and earthquake insurance.
Don't forget to add in the cost of furnishing the house also – drapes, rugs, and furniture. It's not a simple matter of comparing your rent payment to a mortgage payment. Play around with the NYT Rent vs Buy calculator and you'll quickly see what I mean.
#7 You Won't Want to Live in That House as an Attending
I counsel graduating residents to try to live like a resident for a while to get themselves set up on a solid financial footing, but the truth is that almost everyone upgrades their lifestyle at least a little upon residency graduation. That 1400 square foot bungalow that seemed like a mansion compared to the 500 square foot apartment you had as a med student isn't going to seem adequate when those attending-size paychecks start rolling in. For most graduating residents, staying in your residency house isn't even an option since you're starting a job (or a fellowship) in another city.
#8 Home Maintenance Costs Either Time or Money
When you rent, much of your home maintenance will be taken care of by the landlord. Fixing broken appliances, repairing leaky roofs or windows, cutting the lawn, or removing snow all costs either time or money, neither of which is abundant for a resident. The less of this you have to worry about, the more time you can spend learning medicine and the more money you can use to stabilize your financial future.
#9 Residents Don't Get a Tax Break for Owning a Home
When I originally wrote this post in 2013, I spent about $10K in mortgage interest and another $4K on property taxes, which saved me something like $5K on my taxes. Residents likely can't afford a big enough house that the mortgage interest and property taxes are more than the standard deduction [Especially, with the new higher standard deduction]. A resident likely only has a 22% marginal tax rate, decreasing the value of any deduction they would get. Remember that part of the reason that people say you should own your home is for the tax benefits. You don't really get those as a resident.
#10 Budgeting Is Easier as a Renter
Living on a tight budget isn't ever easy, but it is far easier to budget for a simple rent payment each month than it is to account for the myriad of variable expenses you'll run into as a homeowner. As an attending, you replace an appliance out of your monthly earnings. As a resident, you'd have to clean out your emergency fund to do the same thing. You can also project your housing costs upfront- exactly 36 months of rent for a 3-year residency as opposed to who knows how many repairs you'll have to do and how many months it will take you to sell when you move on to your attending job.
Now don't get me wrong. Sometimes buying a house can work out just fine. You might be in a situation where you can't find anything acceptable to rent. Buying will work out better for a longer residency than a shorter one, and if your spouse works, too, then you may even see some tax benefits from it. It also seems like a decent time to buy, in general, when there are very low-interest rates. But for these 10 reasons, the default option for a resident should be to rent, not buy.
What do you think? Do you think residents are better off buying or renting? What did you do? How did it work out? Comment below!
Interesting post. But what if you buy a multifamily while you live in one unit and rent out the others? You can hire a property manager to manage it and even keep it as a rental after you move. I think that’s worth it and different than buying a single family house.
Depends on the performance of the investment property. So if you’re going to do this, look at it as an investment (i.e. run the numbers) rather than choosing it based on consumption type characteristics.
Right, shouldn’t the title be buying a house based on consumption type characteristics instead of being so general?
You think I should have titled the article “10 Reasons Why Residents Shouldn’t buy a House Based on Consumption Type Characteristics”? Really? If I had done that you probably wouldn’t have read it and complained about it. If nobody reads my articles, I can’t help anyone. Thus, I have to write titles that cause people to click on the article or email. I certainly don’t think this is a particularly misleading title, especially since most residents are buying based on “consumption type characteristics.”
via email:
For some reason at my medical school (Loyola in Chicago) they had a realtor come in at the end of 4th year and give us a huge speech/PowerPoint on why we should buy a house when we started residency. My mom talked me out of it for the reasons you mentioned (#1 “you don’t have any money for a DP” which was true I only had 200k in med school debt 😂 now gone thank goodness)
Anyways it might explain the phenomena of the 4th year being so excited to buy a home. I had never thought of it until I heard the lecture which made it sound like a great investment. She said she had a “network” of realtors all over the country to help us as well. So crazy in hindsight.
Just FYI!
I found your blog a couple years after we had started residency…and had already bought a house With a doctor loan. 😂 We were very lucky that we bought in Mid-2011 and sold at the end of 2014 with $60k in appreciation (33%) so we came out well ahead by buying since real estate was on an upward recovery after the earlier collapse. But if we were to do it again in today’s market…Probably not. Obviously hindsight is 20/20 and you never know what is going to happen for each individual circumstance, but you raise some good points to consider!
I purchased a house with the intent to turn in into a long-term rental property after residency. I’m trying to turn real estate into a side hustle a la passiveincomeMD/semiretired MD. To that end, my wife is studying for her real estate license so she can obtain real estate professional status. I’m sure there will be difficulties, such as having to manage it from long-distance should we move, but I’m rationalizing that as part of the learning experience. I’m also hoping I can have a steady stream of residents to rent to, who will hopefully be reliable tenants.
I’m confident you will have a learning experience. 🙂
Hope it works out well. Sometimes it does.
Great post
As with anything there are exceptions. If your home/condo as a resident is in a great rental area, and projected rent would cover your costs, buying as a resident and transitioning to landlord as attending is an option. It worked out tremendously well for me, but bought in 2004 when rent ~ mortgage. Individual markets vary dramatically, and it meant having to scrimp and save twice for downpayment (condo as resident then house as attending). In the long term, 15-20y later, it has paid off
Okay, if you’re willing to keep it for 15-20 years, it’ll probably work out okay. I think that’s a pretty tiny percentage of residents looking to buy and most of those don’t buy the condo by looking at investment criteria, they buy it using consumption criteria.
What has your return been over that time period on this condo as an investment? How would that compare to buying a different property, investing in the Vanguard REIT fund, or just in a total market fund?
What are your thoughts on buying after residency, but during fellowship?
I matched into two one year fellowships (back to back) in the city my wife and I plan to stay in long term, and where my job prospects seem promising (in my field, should make at least $280-350K/y in academic medicine or $400K+ in PP). We have about 70K in savings (excluding our IRAs) and another year to save before the fellowship begins.
It’s a pretty high cost of living area; “starter homes” (think older bungalows) range from $350-470K to buy (or $1700-2500 to rent) while a slightly newer, larger house that would suit us long term seem to run $480-600K. Based on the rent vs buy calculators we’ve run, buying often seems to win out, but we don’t know if we should rent 1-2 years first just to be cautious.
Thoughts on purchasing a home (with 20% down) in the current market for a 5-year military residency in an area where rent is 3x the cost of a mortgage (and almost double our housing allowance)?
5 years should be long enough to have a 50/50 shot of coming out ahead in most places. If you really want to own for some reason, that’s long enough to give it a try I think. Just realize it really is something like 50/50.
It’s not about rent vs mortgage payment though and has nothing to do with your housing allowance. It’s about all the costs of owning (including transaction costs) and all the costs of renting.
Try the NY Times buy vs rent calculator to confirm your suspicions. It’ll take a lot into consideration than you seem to be thinking about.
How much would you let your personal appraisal of the market affect your decision?
For instance, I’m heading into a 3-4 year residency in San Fran right now. The market (for both buying and renting) in this major city is down (20% and 27% respectively), which makes me more excited to buy. There’s no guarantee it bounces back to what it was, but it’s hard to expect it not to go up at all…
We are also lucky in that my partner has an actual income so #1,2,3, and 9 don’t necessarily apply. We are mostly stuck on the short length of the residency and the probability that we are underestimating the cost of home ownership.
That’s just speculation. You could win, you could lose. Without a functioning crystal ball, I wouldn’t let it affect the decision much.
Fair enough – thanks for responding so quickly
I have a hard time with a lot of your advice on home buying as a resident because while many of the arguments made are sound advice, many are comparing apples to oranges. For example you harp on this idea of living as a resident for a few years even when you have an attending level income but then also say attendings won’t live in the same house you bought as a resident. There is no consistency between these two thoughts. There is also the possibility of keeping the house you bought in residency as a rental or airBnB to get a jump start on your real estate profile. Considering many residency locations are in college towns this can prove especially valuable and is what I personally have done. Also most of the time you say if you only live in the house for 3 years as a resident it is not worth the time/money. To my knowledge the only residency that is 3 years is family medicine. Most fields are requiring at least 4 years + fellowship or further sub-specialization like IM to cardio. Most surgical fields (ortho, neuro, plastics, vascular), radiology, IM with fellowship, and many more are all looking at 6 years, which you have commented that the longer the residency the more buying a house is worth it. There was also a previous comment about how much lawn maintenance should cost, and 1k being expensive vs. buying your own lawnmower for 100$ and doing it yourself. Again, it seems that the live like a resident argument is only applied when convenient. Truly living like a resident would mean getting outside and mowing your own lawn, not hiring people to do it routinely. So I have a hard time following many of these contradicting viewpoints.
Well, let’s see if I can help you reconcile those two pieces of seemingly contradictory advice. Remember also that it’s your money and your life. You can do whatever you want with both and don’t need my permission.
The general principle of house buying is that the longer you stay, the more likely it is to appreciate enough to overcome the transaction costs. Everything else is just window dressing and rules of thumb.
Now, the reconciliation. Most docs won’t live like a resident at all after residency. They’ll be buying that attending house before they even leave residency. That’s one point I’m making. The second is that even for those who live like a resident, they’ll typically only do it for 2 or 3 years or so before they’ll be sick of it and go get an attending house. So one shouldn’t look at a house they buy in residency as something they’ll be in for 10 or 15 years, much less forever.