I’m getting close to being 6 months into my first job post residency and I have felt myself getting the urge to buy a house. The biggest factor came when my fiancee moved into my one bedroom apartment and we quickly realized that we simply do not have enough room. I find that my desire to buy a house is always at its peak when I write a check for $1,800 for a 800 sq ft apartment close to where I work. It’s hard not to feel like I’m “throwing money away” renting and not buying. Especially now that I plan on staying in this city for several years to come. Now that I know I like my job and the city, the next step is wondering if I should buy a house or continue to rent a cheaper apartment.
What are all the cost with buying a house:
- Down Payment: Ideally 20%, but not required. Physicians loans will allow as low as 0% down
- Closing Costs: Varies with bank, could be flat rate but most commonly 2-5%
- Home Inspection: Varies but expect $400-$1000 depending on size of house, market, and how extensive the review
- PMI: If down payment < 20%
- Real estate attorney. This can be highly variable. usually $1,000 to $3,000
- Escrow Can be flat rate vs percent of purchase
- Origination fee on a loan: 0.5 – 2.0%
- Property Taxes
- Home / Flood Insurance
- 1-3% annual maintenance
- HOA Fees if applicable
- Increased utility costs
- Landscaping if applicable
One time purchases for new house
- New or additional furniture
- Landscaping equipment
- Changes upon moving in. For example, painting a wall or other changes upon moving in
- Replacing locks: $50/door
Can I afford to buy a house?
I still have student debt so the first thought is why take on more debt? Just because a bank is willing to loan money does not mean that buying a house may be a good idea. Lets take a brief look at my monthly current budget on an assumed income of $250,000 a year.
|Student Loan Payments||4000|
My budget includes a large amount being allocated to student loans since I want to pay them off in 2 years or less. I could decrease my contributions to my loans at the costs of paying my loan over a longer period of time but I want to be free from student debt. Once I’m done paying my student loans, my plan is to use the money I was spending on loans to automatically increasing my savings rate by 33%. According to MMM, a saving rate of about 45% will allow me to retire in 20 years at the age of 50 but that is a post for another day. Heck, I’m shooting for a savings rate that will allow me to retire in 10 if I wanted to.
How much should I spend on a house?
Articles like this one from wall street journal encourage people to limit spending to a quarter of their net paycheck on their mortgage. The other method is to use gross income to determine what the maximum house one can afford.
- Using the gross earnings method to calculate the maximum purchase price is one of the most common ballpark methods. The usual range recommended is 2-3 times gross income.
- The other method as listed above is to allocate 25% of net income on the conservative side to 35% on the aggressive side spent on mortgage payments.
Using the 2-3X gross salary calculation:
Doctors with student debt can not use this equation, or if they do it has to be modified.
Predicted max mortgage: (Gross income X 3) – Student loan debt
Using my budget example as above, my gross income is $250,000. Using the 2-3X gross salary method gives a recommended spending level of $500,000-$750,000 to be spent on a house. However, I have student loans to pay and these need to be taken into account. Subtracting my $80,000 in debt from $750,000 gives a maximum house price of $670,000.
If I were to buy a $750,000 house the mortgage payment for a 30 year loan would be around $5,100 or $6,764 for a 15 year mortgage. With my current budget as above, a 15 year mortgage on a $750,000 house would force me to change my student loan contributions. It would also force me to dramatically decrease my savings rate pushing back my possible retirement date. I don’t really care to work 10 extra years to live in a house that is too large for my income and level of debt.
Note: I have no interest in going down the IBR or PSLF route since my debt level is not so significant that it would cripple my chances to buy a house in the next 5 years. Also, since I refinanced this is not an option. For some graduates with high debt loads, choosing to pay off the loan in 10 years on a standard plan and buy a house may not be practical.
Using the 25-35% net income calculation:
My net pay post taxes and retirement in the example above is close to $12,000. Using the percent of net pay method to determine what house I could afford means $3,000 to $4,000 a month be spent on mortgage. In Texas, this would buy a house around $400,000-$550,000 at current interest rates. The upper limit of what I can afford suddenly has decreased quite a bit. This method of calculation is much more affordable and would not force me to change my student loan contributions. It also would give me a chance to use the MMM simple retirement math to ensure that I can retire in 20 years or less by having a savings rate >50%.
Now that I have some thoughts about what price I might be able to afford, what about the benefits of renting vs owning:
The benefits of buying a house
- Typically houses over long periods of time appreciate in value but are still subject to market fluctuations
- Build equity
- Interest and tax portion of mortgage is a tax deduction
- Once its paid off, only taxes, maintenance and heating and cooling to pay
- I plan to enter into real estate like Passive Income MD and turn my first property into a rental property to build additional income
- More privacy
- I would like to have a backyard
- As an avid DIY fan, projects to fix up the house and add sweat equity seem appealing to me
Benefits of renting
- Since undergraduate, I have not spent more than 4 years in the same city. The need to frequently move never made buying an attractive opportunity. For medical training I needed to be flexible and mobile for wherever I may end up being accepted.
- My rent payments were much less than any mortgage payment would have been. In medical school I paid between $300-500 a month for my rent. Even in a low cost of living city it would be very difficult to get a mortgage with those monthly payments. According to the Zillow calculator, I would have to buy a house worth about 70,000 to have a similar mortgage payment. The 2 bedroom condo I lived in medical school had similar units for sale for around $220,000. Assuming someone bought the condo for that price, they would be renting it out at a loss each month in the market I rented it in.
- Maintenance is all on the landlord, which is great since I never had free time. My air conditioner failed twice and my shower broke once spraying water everywhere. The cost of having a plummer and HVAC person come out was entirely on the landlord.
- Being new to the city, renting let me try out a neighborhood to see if I like the location.
- No stress at moving time. I have several friends who did buy at the start of residency and things did not turn out so well for them. I went to residency in Houston where since the oil crash, housing values have taken a nose dive as well in the past several years. One of my best friends bought his 2 bedroom condo for $150,000 and sold it for $115,000 while having to pay closing costs. He thought about renting it out but the rent market also has decreased significantly which would not have covered his mortgage. He was also moving to California for fellowship where due to the high cost of living he could not afford to keep two places. Sadly, he took a large financial hit with the sale and lost a lot of money in the 3 years that he was in residency.
- A house that you live in should not be looked at as an investment. There are some tax breaks, but owning a house can be expensive.
Ultimately I am deciding to rent for one more year. Without needing the excess space a house can provide, I have found that a house is much more of a want than a need at this point in my life. Maybe this will change later this year, but for now wanting to buy to scratch the itch of home ownership is not a reason to rush into the biggest financial purchase of my life. Who knows, maybe the perfect house will come on the market next week and I’ll submit an offer. I’ll be watching and renting a frugal apartment until then.