The Three Traps to Avoid for First-time Home Buyers

Key Takeaways:

·         Don’t get the largest house that you can borrow. Build a budget to see if you can afford mortgage payments and other house expenses.

·         Mortgage payments are fixed, but your income is not. Make sure you can afford mortgage payments if you reduce your income e.g. working part-time.

·         Make sure your career is stable before buying a home. Needing to move or sell your home is timely and costly.

Buying your first home is a big financial decision. It is a big goal of mine personally and I often catch myself scrolling Zillow in search of my future dream home. Here are the top three traps that you should so you are not stuck with an expensive home that you eventually regret.

Trap 1: Treating lender approval as your budget

Physicians earn on average $250K to $600K a year depending on their specialty. If your student loans and other debt are relatively low, your high income allows you to qualify for a big loan. However, just because you can qualify for one, doesn’t mean that you should take the highest amount.

Here is a rule of thumb on how much mortgage you can borrow: the 36% rule. This means the maximum amount of payments you are making to all debt and house payments is 36% of your gross salary (before taxes).

Example: How much can they borrow?

Bob & Mary want to buy a home with $500K/yr Gross salary

X 36% = $180K/yr or $15K/mo in house and debt payments (mortgage, property taxes, other debt)

That is equivalent to a $1.8m mortgage @7% for 30 years

From this example, the max mortgage Bob & Mary can pay is $15K/mo. That’s a good starting point, but this might not fit their budget. Can they pay this mortgage along with his lifestyle expenses, retirement savings, and taxes? They need to break down their budget too.

Example: How much does the budget allow?

$500,000 Gross Income

-$150,000 taxes

-$100,000 Retirement Saving

-$50,000 Childcare

-$120,000 Living Expenses not including rent

= $80K actual spendable cashflow

With their expenses, they only have $80K/yr ($6.7K/mo) to spend on house payments even though they qualify for a $15K/mo mortgage. They either need a smaller home, a larger down payment or more time renting and saving. Make sure you know your budget before you get your mortgage.

Trap 2: Assuming your current income is permanent

A mortgage payment is fixed for 10 to 30 years, but your income may fluctuate during that period. You need to make sure you can cover your payments even when your income dips. If you get sick, you should have disability insurance to cover your income. Your reduction in income may also be voluntary. You may want to work part-time for better work life balance or to spend more time with your kids. Maybe your spouse that was earning an income becomes a stay-at-home parent to take care of the kids. Having kids could happen a couple years after buying a home, so it’s still important to talk about these things beforehand to plan ahead.

I experienced peaks and valleys in my own income. I took a big pay cut changing careers from investment banking to financial planning. I’m glad that I had cash on had and I didn’t have a mortgage. I’d imagine having a mortgage makes a career change a more difficult decision. If you are looking to transition into private practice with your own clinic, do you have enough saved up to not only to pay your mortgage and expenses, but also to pay for large startup costs with office rent and equipment. Make sure you save up enough to cover your mortgage and lifestyle expenses, and account for the low income in the initial year.

Here is an easy test to see if you can sustain future dips in income. Go back to your budget and see if you can afford your mortgage if you were to work 0.8 or 0.5 full-time equivalent. If the mortgage immediately forces you to abandon retirement savings, the home may be too expensive.

Trap 3: Underestimating the difficulty of moving elsewhere

When you own a home, career transitions become more complicated because you can’t pack up your property in your suitcase. If our friends, Bob and Mary, receive a better job offer two hours away, they now have to decide whether to commute, reject the offer, or sell the property.

Selling a property takes time and energy. It takes months to list on the market, review buyers, and finalize the sale. There are costs to selling the home like realtor commissions, title insurance, and government fees that could leave you with much less money than expected from the sale.

If you have a non-compete clause that forces you to work a distance from your old job, like 10 miles. You want to make sure that you read your contract with a lawyer to know what the potential risks of being terminated are.  

To help you think through these problems, you should ultimately ask this question: How ready am I to settle down? I have created a list of questions for you.

Question list: How ready are you to settle down

1.      Can I work at my job for 5 more years?

2.      Do I want to stay in this neighborhood for a long time?

3.      Do I have any desire to explore different cities?

4.      Is this house enough if I have kids in the future?

5.      Do I have a non-compete clause with my job?

6.      Do I like moving and living in new homes?

After answering these questions, you may have a better understanding of whether home ownership truly matches your life situation.

This article is for educational purposes only and should not be considered individualized financial, tax, legal, or investment advice.