Should you buy a house in residency?

Happy (belated) Match Day, everyone!

Now that the dust is starting to settle, I bet at least half of the graduating medical students in the country have been on zillow shopping for houses. I know because I did the exact same thing. I think my husband’s new hobby for the last month leading up to match day was looking at the houses we could buy in each of the cities on my match list.

In fact, the cost of real estate in our city came up in several of my program’s interview dinners this year. As a homeowner, I would love to be able to tell people that buying a house in residency is a good idea. And as it turns out, the cost of real estate in my area is actually very low. My husband and I bought a wonderful house that we are very happy with. So I’m not saying you should never buy a house in residency. What I am saying is that you have to go into it with your eyes open.

A numbers game

I talk to a lot of people who plan to move after residency – even if they are going to stay in the same region, most don’t want to stay in the same house, or even the same town. They tell me that they plan to buy a house when they start residency, then sell it when residency is over.

The math that they give me usually looks something like this:

I’ll buy a house that costs $150k. I’ll pay my mortgage for the four years of residency, then when I graduate I’ll sell the house and I’ll get all of my money back! In the end, I’ll be rent-free!

So how does the math actually work?

There are two key things that most first-time home buyers forget about: amortization and costs of sale. These two things, unfortunately, wreck that math, and they can be a real sucker-punch if you don’t know they are coming. I will use a theoretical $150k house. We’ll start with costs of sale.

Costs of sale

First-time home buyers often forget out about the costs of selling a house. When you buy a house, most of the fees are borne by the seller, so people often don’t realize how much it costs to sell a house. As a buyer, you typically pay closing costs, but they can be rolled into the mortgage. Depending on the market, sometimes the seller even pays these costs for you. But when you are the seller, you may have to return the favor! The seller also typically pays the fees for both the seller’s agent and the buyer’s agent, which (in most markets) comes to 6% of the sale price. When you factor in the inevitable deferred maintenance (i.e. the stuff you have been putting off while you owned the place but that has to be done in order to sell it), and other miscellaneous costs such as paying the mortgage while you are selling the house and the total cost to sell a house can approach 10% of the sale price. So if you sell your house for $150k, you should only expect to net $135k.

Amortization

Most people make the assumption that each mortgage payment includes an even amount of payment on the amount borrowed (the principal) and interest. For example, they assume that if they borrow $150k at 5% interest per year, over 30 years, that each year they pay $150k/30 years, plus 5% interest, more or less. In fact, the banks are smarter than that – banks skew the payments so that your first few years’ payments are mostly 30 years’ worth of interest. In the first 4 or 5 years, almost all of the money that you pay the bank for your mortgage goes to paying the interest on the loan, not paying down the original amount borrowed. So what does that mean? That means that if you take out a 30-year fixed rate mortgage at 4.5% then your monthly payment will be $760. After 4 years, you will still owe $139,300 and will have paid $26,600 in interest.

What does that mean?

It means that if you buy a house for $150k, and sell it in four years for the same $150k, you will get to keep $135k but will still owe the bank $139k. You will have to write a check for $4k.

So what do people do?

Well, people count on the fact that the real estate market goes up, in general, over time. People often quote an average appreciation of 6% per year, so we would expect that after 4 years, your $150k house would be worth $190k. If you sell the house which you bought for $150k for $190k after 4 years, you will get to keep an estimated $171k after 10% sales costs. If you owe $139k, then you come out $32k ahead! That’s fantastic! The problem with this is that, while the market does tend to go up in general, the market is volatile. Some years it goes up 15%, and some years it goes down 15%. What if you buy the house for $150k, and four years later it is only worth $140k? You will have to write the bank a check for $13k when you sell the house. The longer you plan to keep the house, the more likely it is that the house will have appreciated overall. The sooner you plan to sell the house, the more likely that market fluctuations will mess with your math and you will have to write a check.

 

Yes, there are lots of reasons to buy a house, but sometimes the math is working against you….

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