A home is often the most expensive purchase of one's life, although it can sometimes be rivaled by a medical practice, another business, or even a professional education. It should be no surprise that we get plenty of questions about housing, home buying, and mortgages around here. Let's go through the common ones.
Own vs. Rent in Medical Residency
The place to start this discussion is at the beginning of a physician's career during training. Many doctors and their partners have delayed gratification through college, a gap year or two, and four years of medical or dental school. They feel like they've been left behind in life by their peers. When you combine that with the realtor and mortgage industry's insistence that owning a home is the most important aspect of the American Dream, it's no surprise that they all want to buy a house before they've ever received a paycheck.
However, they should all still probably rent their home. They won't, of course. I've been trying to talk them out of buying for the last 15+ years with very limited success. That's fine. On average, they still come out ahead about 1/3 of the time in a three-year residency and about 1/2 the time in a five-year residency. And even when they don't, their newfound attending income usually bails them out of their bad decision.
But you should be aware of two principles when making this owning vs. renting decision:
#1 You need your home to appreciate enough while you're in it to cover the transaction costs of buying and selling it. That's typically about 15%, or five years of 3% per year appreciation.
#2 You can rent a house. Some people equate renting to apartment living. Newsflash! Eighteen percent of single-family homes in this country are rentals. If you want, you can rent a house with a fence and a backyard and a driveway and a garage and granite countertops and wood floors.
More information here:
10 Reasons Why Medical Residents Shouldn't Buy a House
The Ultimate New Resident Physician Checklist: Essential Steps Before Starting Residency
Physician Mortgages
Another common dilemma doctors run into is whether to use a physician mortgage. These mortgages—typically only offered to physicians, dentists, and sometimes other professionals due to their typically high creditworthiness—have several benefits:
- No Private Mortgage Insurance (PMI) despite a down payment of less than 20%
- Ability to close/prove income using a contract rather than paychecks
- Ignores total student loan burden, only focusing on payments due (often $0 due to federal Income Driven Repayment [IDR] programs)
It's typically a good move for a resident (at least one who insists on buying) or a new attending to use one of these simply because they have a better use for their money than a down payment. A down payment has four benefits:
- Smaller size of mortgage
- Smaller mortgage payment
- Ability to get out of a house without bringing cash to the table if the house falls in value while you own it or if you need to get out of it before it appreciates much
- Ability to use conventional financing, which may offer slightly lower fees and/or a lower interest rate (but not always)
However, young doctors have so many great uses for money that a down payment often finds itself way down the list. Think about possible great uses of money for a new attending:
- Pay off credit card debt
- Beef up an emergency fund
- Pay off car loans
- Replace that beater car
- Moving expenses
- Pay off student loans
- Contribute to an HSA
- Take that big European vacation you've always dreamed about
- Save for retirement
- Buy a boat
- Start 529s or UTMAs for kids
Everyone's list will be a little different, but a 20% down payment (perhaps $100,000-$200,000 these days) usually isn't a very big priority. So, most young docs will get a physician mortgage and use their limited cash for one of the other things above.
When Should Doctors Buy a House?
If I don't think residents should buy a house but don't care that you don't have a big down payment, when SHOULD doctors buy a house? When their personal and professional lives are stable. Something like 50% of docs change jobs within their first two years out of training. You can waste a lot of money buying a house and then selling it a year later when you move to another town to start another job.
Make sure you like the job and the job likes you before buying. That might mean renting for another 6-12 months after training. No big deal if you're taking a job in the town where you did your training. But if you have to move, it means you now have to move twice, which sucks.
However, that extra 6-12 months has A LOT of benefits. As an attending managing your money well, you're getting wealthier and wealthier every month, and you'll be in a much better financial position to buy a year from now than you are right this second. You'll have less stress with the purchase, and you'll often buy differently than you would have a year earlier. You'll know the neighborhoods and schools better. Perhaps you'll buy a bigger, better house than you would have before. You're not a pressured buyer, so you're more likely to get a good deal. Sure, housing prices probably rose during that year, but the rest of the benefits of waiting probably more than make up for it. Plus, you won't have to move twice.
More information here:
The Financial Benefits of Avoiding the ‘Cool Place’ to Live
Is Renting Better Than Buying? Why We’re Financially Independent and Renting
How Much House Should Doctors Buy?
The guidelines I've always used when telling docs how much house they can afford are as follows:
- Keep your mortgage to less than 2X your gross income. If you have a $200,000 down payment and a $400,000 income, you can buy up to a $1 million home with an $800,000 mortgage.
- Keep all housing expenses (principal, interest, property taxes, insurance, and maybe even utilities) to less than 20% of gross income.
The principle behind these guidelines is that you don't want to be house poor. You don't want such an expensive house that you can't save for retirement and do all those other financial things you need to do. You want your house to be a source of comfort, not a source of stress.
Unfortunately, there is a housing crisis. I have a separate article (to be published soon) about how to deal with that, but the bottom line is that the advice that I used to give to people in very high-cost-of-living areas is now fit for most people in most areas! That is, if you have to stretch the “2X guideline” above, that means 3-4X, not 10X. And there are consequences to stretching even to 3-4X. You are likely to have to work longer, drive crummier cars, take less expensive vacations, and not put your kids in private school. You don't get a pass on math. The housing crisis also means that instead of (or perhaps in addition to) saving for your kids' educations, you now probably also need to save for their future houses.
How to Help Your Kids Buy a House
Speaking of those kids, the key to helping them is to find a balance between the Die With Zero philosophy and the Economic Outpatient Care philosophy.
Bill Perkin's Die With Zero book advocates spending and giving your money away long before you die. Your kids probably don't need your money when they're 60 and you keel over. That money would buy them much more happiness in their 20s, 30s, and 40s. So, spend and give it away while you're still alive. You can turn money into happiness much more effectively at 45 or 55 than you can at 85.
Stanley and Danko's The Millionaire Next Door book has a chapter in it titled Economic Outpatient Care that argues that adults who are partially supported by their wealthy parents are much less likely to build wealth on their own.
What to do? How to balance these philosophies? Good luck. We're all trying to figure that out, but teaching financial literacy, gratitude, and balance from an early age seems key. At any rate, I think you're better off helping with a down payment than helping to make their monthly payments or, worse, co-signing on their loan. If you give them $5,000 a year from age 5 to age 18 and then let it ride until 30, that should give them a
=FV(5%,12,0,-FV(5%,13,-5000)) = $159,000
down payment in today's dollars. That should help quite a bit. That's a 20% down payment on an $800,000 (in today's dollars) house. You can do more, or less, or none at all. It's up to you. But it seems at least as important these days as helping pay for their college.
More information here:
Problems I Have with the Die with Zero Philosophy
Economic Outpatient Care and the Aspiring Millionaire Next Door
What to Know About Refinancing
Marry the house but date the mortgage. Most people don't have the same mortgage for 30 years. When rates go down or when your credit improves, refinancing is often the right move. Classically, people did a calculation to determine if they would save enough interest to overcome the closing costs on the new mortgage. But if you do a “no-cost” mortgage, where the lender pays all those costs, and you can still get a lower interest rate, it's generally worth going through the process to do so—especially if you can get a rate reduction of half a percentage or more.
Be careful not to fall for the “no cash” mortgage trick, where the closing costs just get added on to the total of the loan. Also, be aware that if you refinance into a new 30-year mortgage, the clock starts over. Part of the reason the payment will be lower is that you are now spreading the payments out over more years. If you still want to be done in a total of 30 years, you need to make extra payments each month to make sure that still happens. Recasting a loan might also be an option for you.
If you need help refinancing, here are the folks we recommend.
15-Year vs. 30-Year Mortgages
The benefit of a 15-year mortgage is that you get a lower rate, and you know for sure the mortgage will be gone in 15 years at most. The benefit of a 30-year mortgage is the flexibility. You can still pay it off in 15 years (or fewer) if you want, but you have optionality. If something bad happens in your financial life, you can go back to making that minimum payment each month for a while. There are other options too, like 5/1 or 7/1 adjustable rate mortgages (ARM) that will usually give you a lower interest rate than a 30-year fixed mortgage and work exactly the same if you're out of the home by the time the rate becomes adjustable after 5-7 years.
Should Doctors Pay Off Their Mortgage or Invest?
One of the classic dilemmas in personal finance is trying to decide whether to pay off debt or invest. Perhaps only the Roth vs. tax-deferred/Roth conversion dilemma is more common. So much goes into the equation, including interest rates, attitude toward debt, available investment accounts, risk tolerance, and more. The bottom line is that you need to look at your financial goals and decide whether to run “leverage risk” to meet those goals. Sometimes, leverage risk is better to run than more market risk, and sometimes it isn't.
There are few right and wrong answers when it comes to this dilemma, and most people will choose something reasonable. Obviously, at extremes, there is a right answer, but most of the time investing, paying off debt, or some combination of both is completely reasonable.
What do you think? What other questions about mortgages and home buying do you have or do you hear frequently?