I have long maintained that owning your home during residency is generally a bad financial move. With the recent increase in standard deduction, it became an even worse move. However, this little piece of advice is probably the most frequently ignored advice I give. Exhibit A, this email I received recently:
My daughter and son-in-law graduate medical school this year and for the most part they are loving what you are offering. The only point of contention is buying a house.
My SIL is insistent he can smartly buy a house and make money in three years. He falls back on paying rent is 100% throwing money away and interest is deductible. He had not thought about interest only being deductible if over the standard deduction (not likely in a residents case) and in the first 3 years, virtually all of their money is going to interest.
I wonder if you could go through the numbers of buying a “typical” resident house. You are right that it is unlikely you will break-even in less than 5 years (despite avid home buyers always pointing to the minority who do), but I think it might open some eyes when they realize their interest is most likely not deductible and they are not paying off their house in any real sense.
Yes, Residents Can Come Out Ahead Buying a House
I figure that on average, you can make money owning a house about 1/3 of the time in a 3-year residency and about 1/2 the time in a 5-year residency. It's a little bit like telling someone not to buy individual stocks. Most of the time it doesn't work out well, but occasionally it does (although more often due to luck than skill) so people can always find someone who did it. However far more frequently the person picking stocks isn't actually doing a good job of keeping track of whether she's making money or not. It's the same with buying a house. You think you made money because you sold it for more than you bought it for. But you ignored all the other costs of homeownership, particularly transaction costs.
Appreciation Matters Most but is Difficult to Predict
Another factor that leads people to make this decision incorrectly over and over again is the cyclical nature of the housing market. People see that housing skyrocketed in price over the last 3-5 years while they were stuck in med school, so they buy for residency, just in time for the downturn. 3-5 years later, the residents coming in “know” that buying a house always sucks and so they don't buy, just in time for the market to go back up and the cycle to repeat.
You see, buying a house for a 3-year residency is the wrong move, but only ON AVERAGE. In those times when the market goes up dramatically most of the purchasers come out ahead. And when the market goes down dramatically, everyone comes out behind. So if you have a working crystal ball, it's a lot easier to know what you should do.
It's actually hard for me to tell residents not to buy homes for many reasons:
- I was a resident in 2003-2006 in Arizona. We rented after getting our shirt handed to us owning from 1999-2003, but most of my co-residents bought and made out like bandits during perhaps the biggest housing boom ever.
- I have lots of advertisers that want to sell you mortgage and realtor services. My conflict of interest is to tell you to buy, not rent.
- I'm a huge fan of ownership. I think most docs eventually should buy a home, own their own practice, have equity investments like stocks and real estate, and start small businesses.
Ownership is a great path to wealth. So when I tell you don't buy a house during residency, it's because I actually care about you and have actually run the numbers. WCI forum members are FAR more adamant than I am on this topic. But if I can't talk you out of it, great! Here are my recommended physician mortgage lenders and realtor service.
If you still can be talked out of it, don't forget my
first published 6 years ago.
- You don't have a down payment
- You don't have any income
- You have a ton of debt already*
- Residency is only 3-5 years long
- You can rent a house
- New homeowners underestimate the costs of ownership
- You won't want to live in that house as an attending
- Home maintenance costs either time or money
- Residents don't get a tax break for owning a home*
- Budgeting is easier as a renter
Two of those factors (the starred ones) have only gotten worse in the last 6 years and the rest are unchanged. None have gotten better. But let's run the numbers to see if maybe that will help someone like the emailer's kids.
You don't have to think about this topic for very long to realize that just because a mortgage is less than a rent payment for a similar place doesn't make buying the right move. Nor does selling the house for more than you paid for it mean you made money. Nor is renting “throwing money away.” If that is as deep as your thought process has gone about buying a house, you have no business buying one at all. There is just a lot more that goes into it than that. Yet those are the three rationalizations most frequently cited by those who are really buying a house to meet some strange emotional, burning desire to demonstrate they've achieved the American Dream.
Running the Numbers
Let's assume, just for ease of calculations, that rent goes up at a steady 3% a year, that you have no money to put down, that your favored mortgage is a 30 year fixed mortgage at 5%, that houses appreciate at a steady 3% per year, that you spend 1.5% of the value of a house on maintenance each year, that your round trip transaction costs on buying and selling a house will be 15%, and that you will sell the house after residency.
I picked a random 3 bedroom house in my residency town. It costs $335K and rents for $2,000 per month. Same same. Apples to Apples. Don't be an idiot and compare buying a four-bedroom house to renting a 1 bedroom apartment.
Now let's run the numbers for a 3-year residency.
The 3-Year Renter
This doc pays $2,000 for the first twelve months, then $2,060 for twelve months, then $2,122 for twelve months. Total housing cost for three years = $74,184.
The 3-Year Buyer
This doc borrows all $335K at 5% on a 30 year fixed mortgage. Adding in $2,000 per year in property taxes and $600 a year in insurance above and beyond what renter's insurance would cost leaves a mortgage payment of $2,032.69. We'll round it to $2,030 just for ease of calculation. So over 3 years, this doc pays $73,080 in mortgage payments. Not much of those payments go toward principal. With the first payment, it's about $402.53. With the last payment, $465.58 goes toward principal. Overall, in three years $15,599.23 goes toward principal. Meanwhile, the house appreciates at 3% per year. After three years, it is worth $366,000. Maintenance costs are 1.5% * 335,000 * 3 years = $15,075. Transaction costs are 5% * $335,000 + 10% * $366,000 = $53,350. Now add it all up.
- Principal Paydown $15,599.23
- Appreciation: $31,000
- Total positives: $46,599.23
- Mortgage payments: $73,080
- Transaction costs: $53,350
- Maintenance costs: $15,075
- Total negatives: $141,505
Grand Total: $46,599 – $141,505 = – $94,906
Yes, you lost $94,906 buying that house. This isn't a money-making activity. The question that matters, however, isn't whether you made money or not. You exchanged $94,906 for housing. The question is whether you could have exchanged less money for housing by renting.
In this 3 year scenario, the renter paid $74,184 for housing and the buyer pays $94,906 for housing over those three years, a difference of $20,770 ($6,923 per year or $577 per month.) Clearly, buying was the wrong move unless your numbers are significantly different than the assumptions here. For instance, if the house appreciates 8%/year, then the buyer would come out ahead by more than $60K! Of course, if the house went down in value at 8% a year, the buyer would come out behind by over $84K!
Let's look at it over a 5-year residency to see how that extra time in the house changes things.
The 5-Year Renter
This doc pays $2,000 for the first twelve months, then $2,060 for twelve months, then $2,122 for twelve months, then $2,185 for twelve months, and finally $2,251 for twelve months. Total housing cost for five years = $127,416
The 5-Year Buyer
Let's use those same $2,030 mortgage payments. Yes, I know I'm not indexing the insurance, property taxes, and maintenance costs to inflation, but remember that makes buying look better than it will actually be and it's a pretty minor effect anyway. Over 5 years, $2,030 a month adds up to $121,800. In those 5 years, $27,400 goes to principal. At 3% a year, the house increases in value to $388,000. Maintenance costs are 1.5% * 335,000 * 5 years = $25,125. Transaction costs are 5% * $335,000 + 10% * $388,000 = $55,550. Add it all up.
- Principal Paydown $27,400
- Appreciation: $53,000
- Total positives: $80,400
- Mortgage payments: $121,800
- Transaction costs: $55,550
- Maintenance costs: $25,125
- Total negatives: $202,475
Grand Total: $120,400 – $202,475 = – $122,075
So the renter pays $127,416 for housing and the buyer pays $122,075 for housing over those five years, a difference of $5,341 ($1,068 per year or $89 per month.) Basically a wash. No guarantee you'll break even, but at five years the likelihood that you come out ahead is about the same as the likelihood that you will come out behind. Of course, this all ignores the hassles of homeownership, which are not insignificant especially for a busy resident.
But What About The Tax Benefits?
You'll notice I didn't include anything about the tax benefits of homeownership. In my opinion, these are dramatically oversold. Even if you can deduct your mortgage interest and property taxes, that's just like lowering your interest rate a little bit.
But with the new, lower tax brackets and higher standard deductible, many residents won't be deducting much of their mortgage interest or property taxes anyway. What tax bracket is a single resident making $60K in? Maybe barely into the 22% bracket and possibly still in the 12% bracket. A married resident with a stay at home spouse? 12%. Two married residents? Maybe barely into the 24% bracket. The SALT tax deduction may make the property taxes completely non-deductible for some two resident couples in high tax states and could limit it for others.
Even in our example above with a $335K house, that first year you're only paying $16K in interest and $2,000 in property taxes. Unless you're giving a bunch of money to charity or paying a bunch of money in state taxes, a single doc would only get a $6K deduction ($6K*22%= $1,320 off her taxes) above and beyond the standard deduction and a married couple wouldn't get a deduction at all since $18K < $24K.
Run the numbers for your situation and you can add those tax benefits into the equation. But saving $1-2K a year on taxes isn't going to make up for huge transaction costs and poor appreciation. Those factors simply swamp the tax bennies for a resident, if they exist at all. And remember we're talking about a $335K house here with a $335K mortgage. That's not exactly a cheap house. On a $60K income, those $2,030 mortgage payments are eating up 41% of your gross income. If you buy a more sensible place like $100-200K, the chances of you itemizing go way down.
What If I Don't Sell After Residency?
Don't kid yourself. Almost every doc sells the house after residency and those who don't wish they had. Sometimes, if the market is down you can't find anyone to buy it. Or you're so far underwater that you can't bring the cash to the table required to sell it. Maybe you think you'll rent it. You probably can, but there's a decent chance it'll turn into a long-distance landlord situation, which sucks, and even if it doesn't turn into that, it probably won't be a great rental because you didn't buy it as a rental in the first place.
We tend to overpay for homes we want to live in compared to what a savvy real estate investor would pay. You think you'll keep living in it? Fat chance. While I'd love for you to live like a resident for a solid 5 years afterward, the truth is that very few attendings are happy living in resident accommodations for long after residency.
So, if the emailer's kids read this post (and I emailed it to him to share with them months ago) I hope they'll think long and hard about their decision, run the numbers, and go into their home buying experience with their eyes wide open. While I have long since given up on trying to talk residents into renting due to the strange, illogical burning desire to acquire a mortgage found among graduating medical students and especially their spouses, I would hope that they would at least consider renting. It really should be the default option for residents.
What do you think? Do you think the average resident should rent or buy during residency? What do you see as the exceptions to the general rule? What did you do? How did it turn out? Comment below!