ACP: Career Counseling - Buying a Home

Residents & Fellows

Buying a Home

by Patrick C. Alguire, MD, FACP
Director, Education and Career Development

For many residents and fellows, leaving training and beginning practice is associated with purchasing a new house. This article will deal with what you can afford, and how to begin looking. Other articles will deal with mortgages and closing costs.

How Much Money Do I Need?

Traditionally, prospective home buyers were told to have enough cash for a 20% down payment on a new house, plus 3% to 5% of the purchase price to cover closing costs, and an additional amount of cash to cover 2 to 3 months of monthly housing expenses.

Recently, lenders have become more flexible and willing to finance as much as 95% or more of the purchase price. This is because lenders now sell their home mortgages to the Federal National Mortgage Association ("Fannie May"), thereby reducing their risk. But there are downsides to making only a 3% or 5% down payment. Low down payments are associated with low home equity and increased interest payments. With so little equity in your home, the lender may insist you purchase "home mortgage insurance" that protects the bank if you cannot make payments. Home mortgage insurance can run as much as $2000 annually. Low down payments leave a high principle upon which the interest is calculated. In the long run, a low down payment may save you cash up front, but will cost you considerably in interest payments over the life of mortgage.

Deciding how much to put down on a home requires that you carefully assess your current and future financial obligations. Outstanding big-ticket items like paying off your student loans, buying a new car, or redecorating the new home may limit the amount of your down payment.

Will I Get the Loan?

The most important factor determining whether you get the loan is your ability to meet your loan payments. Your ability to meet payments is calculated by the lender as a function of your income and debt.

To assess your ability to pay, the lender makes two calculations. The first is known as the housing ratio. Quite simply, the housing ratio is the percentage of your gross monthly income that is needed for housing expenses after purchasing the house. Housing expenses include the monthly mortgage payment, taxes, insurance and maintenance. Ideally, this ratio should be 28% or lower. The mortgage payment is probably the single greatest contributor to the monthly housing expense, and it can be lowered in a variety of ways. Stretching the mortgage payment out to 30 years will decrease the monthly mortgage payment, but will cost you in interest over the long run. Increasing the amount of the down payment will decrease the mortgage payments, and result in a more rapid growth in home equity. Finally, the type of mortgage you purchase can influence the monthly payment.

The second calculation is the total obligation ratio. This represents the portion of your gross monthly income that covers your housing expenses and other outstanding debts or obligations such as credit cards, car loans, student loans, and the like. Using this calculation, the lender prefers to see a ratio of 36% or lower.

These rules are not inflexible. The lender will look at all relevant data, including your current income, potential income growth, interest rate on the loan, and the cost of property taxes and insurance. The Fannie May web site (www.homepath.com) is a great source of useful information, including a "How Much House Can You Afford?" worksheet and calculator.

How Do I Start Looking?

Real estate brokers typically work for the person selling the house. They are paid a percentage of the sale price, usually around 6%. Therefore, they have an incentive to get the highest price possible for their customer's house. Remember that these brokers may appear to be helping you, but they are not working for you. Do not share confidential information with seller's brokers, especially how much you are willing to pay, since this information will go right back to the seller.

Buyer's brokers are becoming more common. They work for you and can be invaluable when you are moving to a new part of the country, and have limited opportunity to hunt for houses. Buyer's brokers can save you time by pre-screening for houses that meet your previously established criteria, take you to the neighborhoods with the best schools, or find houses in locations that meet other special needs. Another asset of working with a buyer's broker is they have access to a huge database of houses from which to choose. Buyer's brokers can be paid by the hour, or by the percentage of the purchase price of the home. Obviously, neither of these arrangements offers the broker any incentives to work quickly or find the least expensive house that meets your needs. Occasionally, you can negotiate that your broker to split the commission with the seller's broker; typically each broker would end up getting 3% of the purchase price as their commissions. Signing up with a buyer's broker usually obligates you to work with the broker for a specified period of time. This limits your ability to find a house on your own, or using other brokers. Be sure your understand the terms before coming to an agreement.

If your are moving to another town and don't have access to the local newspaper, another convenient source of housing information can be found on the Internet. The National Association of Realtors (www.realtor.com) maintains a nifty site that allows you to search for homes by location, price, square footage, and other characteristics. Many times, a photograph of the home's exterior is provided as well.

Finally, one of the most difficult tasks while house hunting is keeping all the houses straight in your mind. Which house had the lovely yard, but terrible kitchen? Which house came with the swimming pool and a leaky basement? To help keep the house hunting data organized, you can use the house specification sheet provided by the broker, or you can use a worksheet. One such worksheet, "House Hunter's Helper" ( www.hypervigilance.com/househunt.html) is available on the Internet.

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