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As a new physician, you’ve sacrificed years watching friends buy new cars and first homes, while you’ve spent an extra four years in medical school with no income. You followed that up with three to nine years of residency and fellowships at depressingly low-income levels. It’s no wonder then, when you finally get your new attending salary, you want to go buy a “doctor house.”

We urge you to use restraint when buying your first real home. After all the years you’ve sacrificed, the last thing you want to do is purchase a home that leaves you no freedom to enjoy other things in life.

How Expensive of a Home Should You Buy?

We advise our clients to stay within two times their salary when purchasing a home. If your gross income is $300,000 a year, you should look for a home that costs $600,000 or less.

Times you may want to deviate:

  1. If you are currently in residency and are going to have a significant, known increase in salary, use your upcoming salary for the income calculation.
  2. If you live in a particularly expensive housing market, you may need to go over the two times limit. If you do, we recommend not going over two and a half times your income.

Banks will typically allow you to buy a house up to three times your gross income. The banks are not doing you a favor by allowing this. They are in the business of lending money and collecting interest. They would like you to borrow as much money as they believe you are capable of paying back without defaulting. Banks are not concerned with your ability to save for financial independence, family vacations, or education for your children.

Bank Home Buying Ratios

Banks use standard financial ratios to determine your suitability to purchase a home. These ratios can be confusing to new borrowers.

Before we explain the ratios, it will help to have an example home buyer in mind. Let’s assume our couple, Craig and Kerry have:

  • A combined gross income of $300,000 ($25,000 a month) that will increase to $450,000 ($37,500 a month) in two years
  • No consumer debt (yeah!)
  • Student loans of $300,000 with a monthly payment of $3,000 (Planning on PSLF)
  • Their plan is to purchase a $600,000 home
  • The mortgage payments are based on the 20/10/1 Rule described later in this article
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Debt-to-Income ratio = monthly debt payments/monthly gross income

Also, known as the Back-End ratio, this is the main ratio the banks use to determine suitability.

The Debt-to-Income ratio includes all debt and housing expenses. Consumer debt includes student loans, automobile loans, other consumer loans, and credit cards debt.

Housing expenses include your mortgage principal and interest (PI), property taxes and homeowners insurance (TI), HOA fees, plus any mortgage insurance.

We recommend keeping your Debt-to-Income ratio below 30%.

Craig and Kerry’s total consumer debt is $3,000 because of their student loans. Their housing expenses are $2,292 principal & interest (PI), $800 taxes (T), and $100 homeowners insurance (I). Total PITI is $3,192. (See the 20/10/1 Rule mortgage details below)

If you have student loans and you are basing your home purchase on your future attending salary, remember your income-drive-repayment is going to increase as your salary increases.

Craig & Kerry:

  • $3,000 + $3,192 = $6,192
  • Current salary Debt-to-Income ratio is $6,192 / $25,000 = 25%
  • Future salary Debt-to-Income ratio is $6,192 / $37,500 = 16.5%

Maximum bank ratios are 31% for FHA loans, and 38% for most other bank loans.

Consumer-Debt ratio = non-housing debt/monthly gross income

The Consumer-Debt ratio includes all “non-housing” debt and excludes housing expenses.

Keeping the Consumer-Debt ratio under 10% is considered excellent.

Craig & Kerry:

  • Current salary Consumer-Debt ratio is $3,000 / $25,000 = 12%
  • Future salary Consumer-Debt ratio is $3,000 / $37,500 = 8%

Front-End ratio = housing expenses/monthly gross income

The Front-End ratio can be thought of as the inverse of the Consumer-Debt ratio. It includes all housing expenses and excludes consumer debt.

We recommend keeping the Front-End ratio under 20%. Banks typically want this below 35%.

Craig & Kerry:

  • Current salary Front-End ratio is $3,192 / $25,000 = 13%
  • Future salary Front-End ratio is $3,192 / $37,500 = 8.5%

How Much Money Should You Save Up?

How much money to save up before you purchase your first home and the related question of how to finance your home purchase, are widely debated. Ultimately the decision is up to you. My goal here is to make sure you understand the tradeoffs and consequences.

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Make sure you plan for the costs of moving, furnishing, and renovating your new home. It is easy to dismiss the cost of lawn mowers, curtains, rugs, etc. when buying your first home. These expenses can quickly add up to 10% of the purchase price of your first home.

The best way to buy a home is with a 20% downpayment, 10% saved for expenses, and 1% for unknown contingencies. This will get you the best interest rate and give you the flexibility to get everything set up the way you want.

20/10/1 Rule

Best way to buy a home for long-term ownership:

  • 20 – Put 20% down on a house.
  • 10 – Have 10% of the home price for moving expenses, renovations, and furniture.
  • 1 – Have 1% of the purchase price for unknown expenses.

$600,000 Purchase Price, $480,000 Mortgage

For a 30-year loan, at 4% interest, the PI would be $2,292. I will assume $800 per month in property taxes (T) and $100 a month for homeowner’s insurance (I). The total PITI payment will be $3,192 per month.

Check the local county auditor’s site for property taxes. Property taxes can vary significantly and can make or break your home purchase decision.

For the 20/10/1 Rule, Craig & Kerry will need:

  • $120,000 for a down payment
  • $60,000 for miscellaneous expenses
  • $6,000 for unknowns

Total $186,000 Necessary

This sounds great, but the reality is that most new attending physicians don’t have $186,000 saved up for their first home.

10/10/1 Plan

  • 10 – Put 3% to 10% down payment.
  • 10 – Have 10% of the home price for moving expenses, renovations, and furniture.
  • 1 – Have 1% of the purchase price for unknown expenses.

$600,000 Purchase Price, $540,000 Mortgage

For a 4.25% Interest, 30-year loan, the PI would be $2,656. I will assume $800 per month in property taxes (T) and $100 a month for homeowner’s insurance (I). The total PITI payment will be $3,556 per month.

You also need to factor in the cost of private mortgage insurance (PMI). This amount can vary significantly based on the type of mortgage you use. For our example, we will use 0.44% for PMI which equals $198 per month. This brings your total mortgage payment to $3,754 ($3,556 + $198).

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For the 10/10/1 Rule, Craig & Kerry will need:

  • $60,000 for a down payment
  • $60,000 for miscellaneous expenses
  • $6,000 for unknowns

Total $126,000 Necessary

Again, most new physicians don’t have $126,000 available for a home purchase.

Physician Loan

If you don’t have $126,000 to $196,000 available to buy your home, a physician mortgage is your best option.

Physician loans are typically quite competitive with conventional mortgages. One reason is that physicians rarely default on their mortgages. Banks that provide physician loans can keep the mortgages in-house and make the difference back in reduced defaulted loans. Physician loans also do not include mortgage insurance.

Most articles bemoaning physician loans base their analysis on a 30-year conventional mortgage compared to a 30-year physician loan at a slightly higher interest rate. Obviously, the physician loan loses that comparison.

But, if you take into account the fact that you are paying rent the entire time you’re saving up your 20% down payment, the analysis quickly shifts over to the physician loan.

Even though there is typically no down payment, you will still need 2% – 3% of the purchase price of a home to cover the closing costs for the loan.

$600,000 Purchase Price, $600,000 Mortgage

For a 4.25% Interest, 30-year loan, the PI would be $2,656. I will assume $800 per month in property taxes (T) and $100 a month for homeowner’s insurance (I). The total PITI payment will be $3,556 per month.

For the typical physician loan, Craig & Kerry will need:

  • $12,000 for financing fees
  • $60,000 for miscellaneous expenses
  • $6,000 for unknowns

Total $78,000 necessary.

Conclusion

We have created a simple worksheet for you to work through some of the math for your circumstances. We hope this helps you make your decisions around how much you can afford to spend on your first home and how to finance that purchase. If you have questions specific to your circumstances, please don’t hesitate to contact us or leave a comment below.

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