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?
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ACEP Now: Vol 34 – No 10 – October 2015A. 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.
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9 Responses to “Tips for Physicians on Buying a Home the Right Way”
February 8, 2017
PhilIs there a general rule of thumb of either equity position and/or number of years into a given mortgage term (either 15 or 30 year) when you lose the benefit of the mortgage interest deduction?
Or to state it another way, one “loses” the marginal tax benefit that comes with a mortgage when your principal payments increase (and interest payments decrease).
February 8, 2017
James M. Dahle, MD, FACEPNot really. It’s a bit complicated in that some people never had a tax benefit if their total itemized deductions are less than the standard deduction. Others might still be able to consider the last penny of mortgage interest they pay as deductible if they have enough other itemized deductions.
But when a low interest rate mortgage gets down into a five figure range, you’ve got to start wondering if it is worth keeping that mortgage around. A 3% $100K mortgage only provides $3000 in interest a year to deduct, so perhaps a tax benefit of about $1000 for a typical doc. Yet in order to get that you might be making payments of $20-40K or more a year. The improvement in cash flow might be worth giving up the deduction.
March 8, 2017
Luke SmithI, like many rookie buyers apparently, had no idea that a mortgage payment should be significantly lower than your rent. It made sense when I read your breakdown of where rent money goes though. I bet that taking the time to choose a real estate agent who really has your best interests in mind would be a good way to ensure that you are really getting the deal you want.
March 9, 2017
James M. Dahle, MD, FACEPUnfortunately, most realtors are exceptionally good at selling homes and not so good at analyzing whether you would be better off renting instead. Not to mention there is no incentive for them to do so. It’s like going to a barber and asking if you need a haircut. You need to make that determination either by yourself or with the assistance of an unbiased advisor.
I also find it interesting that your website has the name of a real estate firm in it. I’ll bet most people reading your comment here on ACEP NOW would not have assumed you worked in the real estate industry. Lack of that sort of disclosure is unfortunately very common in the financial services industry.
July 18, 2017
Derek DewittMy wife and I are looking to buy our first home but don’t know where to start. I like that you recommend multiplying the mortgage by 1.8 to get a more accurate account of what you’ll be paying. We’ll have to keep this in mind when looking for houses and possibly change our approach if renting ends up being much lower than that number. Thanks for the tips!
September 2, 2017
Gloria AndreThank you for your post
September 9, 2017
Rachel FramptonYou are so right. A mortgage should be way lower than the average rent. If you are paying the same price than buying a home may not be for you. That’s why it’s so important to find a real estate agent who is willing to put your needs over their commission.
November 19, 2017
Gary ParkerI am completely agree with @Rachel-Frampton. Because when you are purchasing a home, it is critical to realize for others that a home purchase is consumption item, not an investment. It is a dream of somebody. Thanks for sharing it with us.
August 6, 2018
Richard DavisI agree most first time home buyers are hesitant to buy a new house because they think that a home purchase is mostly a consumption item, not an investment. However, it is always great to have a house that you can really call your own home. Great blog by the way. Thanks for sharing.