Home purchases are arguably the biggest purchase we will make in our lifetime. It is very common for a young physician coming out of residency to be facing this decision head on. There are a number of questions that you need to ask yourself when making that very big purchase.
1. What kind of home will I be comfortable in for five years or more?
At the beginning of your career it may not be a good idea to purchase a home that takes up most of your discretionary income. At the same time you don’t want to buy a home that you will want to upgrade in two years. My recommendation is to keep your mortgage and tax costs to approximately 20% or less of your after tax income, unless you have good reason to believe that your income will increase rapidly over your first five years. Here are a few reasons to keep your housing costs low early in your career.
- Large debt load to pay off such as student loans
- Expenses often increase due to increasing the size of your family
- Most doctors change jobs within their first five years
- Gives you more money to contribute to retirement savings early for compounding
There are also reasons to buy a home on the higher end of what you can afford. The most common reason to buy a home on the higher end is that your income is expected to go up considerably and you won’t be happy in a smaller home than what your colleagues have. This does tend to happen occasionally but I would argue that it is an easier problem to deal with versus having a housing budget that takes up half of your monthly income.
2. How much of a down payment should I make?
The reality is that your down payment will have little to no financial impact on your long term plans. The two benefits to putting more money down is that you can avoid paying private mortgage insurance (PMI) and you may be able to get a lower interest rate. These are two added expenses that can be avoided with a larger down payment.
3. How long do you plan to stay in the home?
The average length of time a family remains in a house is 13 years. If there were a study that showed how long a new physician remained in their first home I would guess it is under five years. This is something you need to consider when making your purchase:
- Will I be content in this home in five years, or even 2 years?
- Do I have any plans to move or change jobs in the near future?
- Will my income be relatively steady or will it rise rapidly?
These questions should help you decide what king of mortgage to get. A typical ARM will lock in a rate for 3-10 years and will fluctuate after the time period. The loan is usually amortized over a 30 year time period and will typically have an interest rate lower than fixed mortgages.
If you think you will be in the home for longer than seven years it would be a benefit to lock in a rate on a fixed mortgage. Fixed mortgages are typically 15 or 30 years.
When doing either type of mortgage I would recommend amortizing over a 30 year time period to keep your payment down and maximize your cash flow. Then if you choose to pay off the mortgage earlier you can always increase you monthly payment.
4. Talk to two different institutions.
In Springfield, Illinois there are a couple of lenders that will lend money to young doctors that have little to no money down on a house. The banks will typically do an in house loan and charge a higher interest rate. Because this rate is not a conventional loan there really isn’t a set rate on the mortgage. This means that the bank is going to charge what they believe to be a fair rate for the risk they are taking. Not having a set rate for these loans makes it worthwhile to talk to two different institutions and compare rates and costs.
5. Maybe it would be best to rent for a couple years.
Renting is not a bad thing!! Depending on how you answered the questions above, renting may be a very good idea for your family. The biggest issue is how long you expect to stay in your home. If you think that will be less than five years you are probably better off renting. Think about it – you don’t have to worry about home maintenance, real estate taxes (which are ridiculous in IL!), or the burden of selling the home when you decide to move.
Each of the five items above deserves careful consideration before making a home purchase. Take some time to come up with answers to these questions and you will put your family in a better financial position for the future.
Material discussed is meant to provide general information and it is not to be construed as specific investment, tax or legal advice. Individual needs vary and require consideration of your unique objectives and financial situation.
Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.