Many in the medical community believe residents and fellows should buy their homes – purchasing in the transition period between medical school and residency. This group often has the opportunity to take advantage of “physician mortgage loan” programs through lenders that allow for $0 down. Being that most residents and fellows have limited resources for a down payment, this becomes a very attractive option.
But before you’re ready to get on board, we want to encourage you to weigh the pros and cons of making such a large financial commitment during a very unpredictable time in your life. Owning your home while in medical training is not always in your best interest.
As with any decision, it is important to explore all of your options and work to understand the true cost of home ownership before jumping in.
Financial Considerations
Let’s talk about the money: Up-front costs, Ongoing costs, and Sales costs
Up-Front Costs
Obviously, your up-front costs with renting are limited. There will usually be a small sum required as a security deposit and an application processing fee, but that’s usually the extent of expenses you’ll see outside of your rent payment.
When looking to own, up-front costs are a completely different animal. Let’s assume the newly minted resident uses a Physician Loan Program and has a down payment of $0. While that sounds great on the surface, don’t forget about all the other fees! You’re still going to be looking at required closing costs (inspections, commissions, appraisals, title searches, credit processing fees, prepaid escrow, etc), which usually amount to around 4% of the total loan value. Don’t forget to have the home inspected and tested to make sure you’re buying a good property. These costs are most commonly paid by the potential buyer before the deal closes.
You can often choose to build many of these closing costs into your loan, however, know this will result in having a higher debt payoff and/or higher interest rates. You may also negotiate to have the seller pay these fees, but this will likely raise the price you’ll pay for the home as well. So while there may not be any dollars coming out of your pocket today, the net effect will be the same in the end. Although in many cases it may appear this way – ultimately, there is no free lunch.
Ongoing Costs
One of the biggest advantages of renting is that the costs are easily quantifiable – you know exactly what you’re going to be paying each month – just your rent payment (plus a small amount for renters insurance). Anything beyond that, such as maintenance and upkeep issues, are generally taken care of by your complex, landlord, etc. When that HVAC unit quits on you, it’s not coming out of your paycheck.
When you own a property, not only do you have multiple costs to keep up with, but many of them are variable and difficult to plan for. In addition to your principal payment, you have your interest – this can be anywhere from 3.5% to 18% if you have a 30 year mortgage. Don’t believe that rates could ever be 18%? Check out the historical rates on 30 year mortgages.
Then you have your property taxes – .18% to 1.89% of the home value. They vary considerably by location but you can look up your state average. Tack on homeowners insurance – also varying by location and insurance coverage – another .5%. Throw in mortgage insurance costs (PMI) and HOA fees (if applicable). Then last, but definitely not least, your home maintenance fees. You can plan on at least 2% annual maintenance expenses for a newer home. This spreadsheet may help break things down for you.
Real Estate values go up and down and the ranges are much greater than many realize, especially over short time horizons. You must consider that your property can go down in value by a considerable amount. Against popular belief, real estate does NOT always go up in value.
But despite all of the costs above, homeownership does have many positives! Each dollar paid in is working toward building your net worth and home equity. And when it comes to tax time, you can deduct your mortgage interest which is one of the great benefits of homeownership.
Sales Costs
With renting, you sign your contract and put down a security deposit, and then when your contract is up – you move out. And that’s that.
With ownership, there is a lot more to consider. When you’re ready to move on, it’s not quite as simple as packing up and leaving. Will you hire a realtor? If so, expect their commissions to cost 4-6%. Does your property require updating, painting, or other repairs? Expect this to cost another 1-3% depending on how many changes are needed.
When you own, you also have the burden of time. When time is of the essence, selling a home becomes that much more stressful. You land your dream job, but it requires you to move. What if you can’t sell your house before your new job starts? What if your home value has decreased? You could be looking at a mortgage overlap for a period of time which could be a financial disaster if you’re unprepared.
Non-Financial Considerations
It is important to remember, especially with less-quantifiable scenarios, that not everything affects people in the same way. While a given situation may present great stress to one individual, it may have no bearing whatsoever on the well-being of another. These points are not a one-size-fits-all, but rather just things to consider when making your decision.
Owning a home can be much more emotionally satisfying than renting – it is your space, your safe place, and you can do whatever you want with it! On the other hand, owning it can take a toll on your emotional well-being. Do you have the time and/or resources to pack up and move? Will you pay someone to do it for you? Where will that money come from? Do you have the time to manage your home and keep up with the required maintenance? Do you have the job flexibility to take a morning or afternoon off to wait for a service repairman to come to your home? What if they’re late? Do you have the emergency funds saved for a large repair? These issues are not as much of a problem with renting.
When renting, there is not much risk to consider in the worst case scenario. At most, your property should be insured through a renters policy. Homeownership brings with it much larger liability risks that should also be taken into consideration. If someone were to get hurt while on your property, or if the home burns down, the liability will fall on the owner. These risks can exceed insurance coverage amounts in rare cases.
Making Your Decision
Everyone hopes for the best, but the wise also understand that things don’t always work as planned. If you feel comfortable when presented with your worst case scenario, and can plan for the unexpected, it’s likely that you’re making a smart decision. If not, maybe you should reconsider. Many only evaluate the average or best case scenarios when making major financial decisions, such as buying a home, but this can cause major financial distress in the long run.
Unfortunate Timing
Let’s say you buy a $200,000 home and find a 30 year mortgage to finance your property. Let’s look at some numbers to determine your all-in cost:
Closing Costs: We will assume that you’re using the typical physician loan program with no closing costs (on paper). There will likely be escrow expenses, but we will not account for these.
Ongoing Costs: *Home Maintenance: 2% annually or $4,000/yr *Interest Rate: 5% (1.25% higher than minimal rates because closing costs and PMI wrapped into interest expense) *Principal & Interest: $1,073.65/mo (5% on 30 year fixed) = $12,883.68/yr *Property Taxes: $2,000/yr *Homeowners Insurance: $1,000/yr *HOA fees: we will assume $0 for this scenario *PMI: $0 (higher rate pays PMI) *Tax Savings: $0 (many residents do not exceed the standard deduction – if you do, there will be some tax benefit) *Total $19,883.68/yr or $1,656.97/mo
*Depreciation or Appreciation – example 5 yrs holding period range -40% to +80% based on The Economist Index – 10 City Average
Now let’s say you’ve landed your new job and need to move pretty quickly. Unfortunately, the market has not been so hot and your home has lost 30% in value over your 5 years of ownership.
Sales Costs: *Home Value = $140,000 *Payoff amount after 5 years would be $183,657 (30yr @ 5%) *Realtor fees – 6% on $140,000 = $8,400 *Fix ups to Close – 0% *Proceeds from Sale – $131,600 *Overlap (mortgage or rent for two homes) – $0
In this scenario, you’d end up writing a check for $52,057 to close on the sale. Your total payments over the last 5 years would be $99,418.40. Add that to the closing amount required on your sale and your costs are now $151,475.40.
Contrast this with renting a $200,000 home at $2,000/mo (very high estimate). Your total payments over 5 years would be $120,000.
This scenario would leave you with a loss of approximately $30,000 in just 5 years if you were to buy versus rent. Can you afford that?
Problems: – Not enough equity to cover the unexpected downturn – Higher interest rate adds to total costs – No home mortgage interest deduction – A big check is required to get out of the home in first place.
Some of you may be thinking that this scenario seems a little unreasonable – but we’ve seen similar situations. Is a highway being built in your backyard that you weren’t aware of when you purchased? Did school zoning change and your location is no longer as desirable? Did the housing market go down in general? You always want to plan for a bad scenario that is out of your control.
The Bottom Line
In most cases, purchasing a home will result in greater wealth than renting, especially with longer time horizons. In favorable circ*mstances, the homeowner ends up ahead of the renter even after only 3 years of living in the home. However, life is not always sunshine and roses. It’s the downside risk you should be paying attention to – especially when you start with $0 in equity (or 100% financing). You are skating on thin ice and if things don’t work out as expected, you must make certain you can manage.
