This week we’re going to have some posts on residents and home buying. Today I’m writing about some reasons a resident should pause before jumping in to a new home. On Wednesday we’ll have a guest post from a lender about some ways around the issues residents face when buying their home. On Friday, we’ll discuss evaluating your prospective home as a future investment property, BEFORE buying it.
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 should have bought one, but only because I did a residency in Arizona during the housing bubble and would have sold just before it burst. Some of my classmates doubled their money in 3 years. That’s obviously not a situation that is going to be replicated any time soon. The new interns who were buying houses when we were selling ours obviously took a shellacking when the bubble burst. Here are 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. First, you protect yourself 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. Second, the more money you put down, the more loan options and better interest rates you are offered. There are a few lenders out there 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. Third, a 20% down payment allows you to avoid private mortgage insurance, which doesn’t even help you. It is insurance your lender makes you buy to protect him. Fourth, you may be able to avoid a higher rate “jumbo” loan by putting more money down. Last, 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, the more expensive your options will be. “Doctors loans” are generally your only option, and depending on your state, you may only have one or two 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, forcing you to choose between a handful of lenders willing to do “Doctors 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 those 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 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 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
As an attending, I itemize my taxes and I’m in a high tax bracket. I spent about $10K in mortgage interest and another $4K on property taxes last year, saving 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. A resident likely only has a 15% marginal tax rate, decreasing the value of any deduction he 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 home owner. 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 up front- 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 with very low interest rates and housing much cheaper than it has been for years. 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!
Image Credit: “Île Bonaventure” by jacme31 CC BY-SA