Should you get a 15 or 30-year mortgage?

If you have asked yourself “Should I buy a home or keep renting” and properly considered the pros and cons of buying vs renting a home, you may choose to buy a house. After checking your credit, thoroughly considering your budget, and getting prequalified for a loan from the bank, you may have found a house you like. Now you need to decide what type of mortgage term is best for you.

 

Point 1: Real estate investors may want a 30-year mortgage

If you are a real estate investor who is buying a home for the sole purpose of using it as an investment property that you rent to someone else, then it is generally best to opt for a 30-year mortgage. As a real estate investor, you are using your tenant’s rent payment to pay off your monthly mortgage, so you are less concerned with paying off your mortgage as quickly as possible. Plus, opting for a 30-year mortgage lowers your monthly mortgage payments to the bank. This means you get to keep a larger portion of the rent your tenant pays you. Opting for a 30-year mortgage instead of 15-year mortgage as a real estate investor creates more cash flow each month, which increases your passive income.

 

Point 2: Deciding on 15 or 30-year mortgage varies based on your circumstances

The decision to get a 15 or 30 year mortgage is not as black and white for residential homeowners. If you are buying a home to live in yourself, the optimal loan term depends on factors unique to your own circumstances. For starters, the bank only offers 15 year mortgages to people who meet certain criteria. Only people with a certain credit score and debt-to-income ratio are eligible. Secondly, a 15-year mortgage has the advantage of offering a lower interest rate than a 30-year mortgage. This lower interest rate will save you lots of money over time. I’ll expand on this with the next point.

 

Point 3: A 15-year mortgage saves you money in interest payments

The main perk of having a shorter loan term, like a 15-year mortgage, is that your interest rate is lower AND the time on which you pay interest is shorter. Both of these factors save you lots of money in interest over the life of the loan. For example, let’s say you and your spouse want to buy a home that costs $250,000. Let’s also assume that you saved up 10% for a down payment (or that your parents gave you a very generous wedding gift for $25,000 that you then used on your home). If you chose a fixed 30-year mortgage with a 4.5% interest rate, by the end of the 30 years you would have paid back the $225,000 you borrowed PLUS an additional $185,000 in interest fees. You nearly paid double for the house!

However, if you had instead taken out a fixed 15-year mortgage (which usually comes with a lower interest rate, so let’s say 3.75% interest), then you would have paid back that $225,000 in 15 years in addition to paying only $69,000 in interest. By opting for the 15-year mortgage you paid off the home in half the time and saved $116,000 in interest payments! I don’t know about you, but I can think of a bunch of things I’d rather do with $116,000 than pay it to a bank in added fees. You are going to pay a lot of money in interest regardless, but the difference in interest you would pay on a 30-year mortgage compared to a 15-year mortgage is HUGE.

 

Point 4: A 30-year mortgage has lower monthly payments

In case I’ve just convinced you to opt for a 15-year mortgage, let me remind you of one downside. In order to pay the loan in 15 years, you have to pay the bank a much higher monthly payment. Using the example from above of a 250,000 home with a $25,000 down payment and a $225,000 loan, the payments on a 15-year mortgage at 3.75% interest are $1,919 per month.  The monthly payments on a 30-year mortgage at 4.5% interest is $1,423 per month, which means you pay almost $500 less each month. For many people, that difference of $500 is huge. They may want to take that $500 and put it into their 401K retirement account. Or, they may want use that $500 to pay back student loans, credit card bills, or other high credit card interest debt.

 

Point 5: There are other ways to save money in interest if you opt for a 30 year mortgage

Keep in mind that if you decide to get a longer mortgage term initially, all is not lost. The interest you pay on your mortgage over time will be higher, but there are ways to combat this. You can: 1) pay more than the required payment each month on your mortgage (if there is no prepayment penalty), 2) send in extra monthly payments each year, or 3) refinance your mortgage to a shorter term after a few years to lower the interest rate.

 

To Summarize, if you’re a real estate investor, you may want to opt for a 30-year mortgage. This will lower your monthly payments and increase your monthly cash flow. If you’re buying the home to live in yourself, it depends.

·      You may want to opt for a 15-year mortgage if you are established in your career with a steady salary and can afford the higher monthly payment.

·      You may want to opt for a 30-year mortgage if you would rather have lower monthly payments (at the expense of a higher interest rate) in order to pay off high-interest rate debt (credit cards and student loans) or fully maximize the employer match of 401K retirement accounts (if you have one).

If you decide to opt for a longer mortgage term now, you may be able to pay off the loan faster in other ways (i.e. by sending in extra payments, paying more than the minimum each month, or refinancing later).

5 Things To Do Before You Buy A Home

As a young professional, one of your biggest decisions is whether you should buy a home or keep renting. After thoroughly considering the pros and cons of buying a residential home, you might have decided that buying a house is the ideal choice for you. Before you start the home-buying process, here are 5 things you must do before you purchase a home:  

1.Get an official copy of your credit report. Your credit report plays a big role in whether you can purchase a home. It determines the interest rate on your mortgage and can even be used to estimate how much money the bank will loan you to buy a home. Your job as a [future] homeowner is to get an official copy of your credit report from all 3 of the major companies that compute it (Experian, TransUnion and Equifax). You need to make sure there aren’t any false charges, incorrect debt amounts, or fraudulent claims on your credit report that are negatively impacting your credit score. Once you see your actual credit score, you’ll be able to estimate the interest rate on the mortgage and determine your monthly payments on different loan amounts.

2. Learn some basics about the local housing market. You will have a better chance of finding your ideal home if you gather some preliminary information about the housing market first. Go onto real estate websites like Zillow.com and get an idea of housing prices in your desired area. Look at recent selling prices, especially in certain desirable neighborhoods. You should also search for new developments and the construction of new homes.  Your real estate agent may have a few places in mind, but it is helpful if you have an idea of the housing market for yourself, doing so will give you a more realistic idea of what’s available within your price range and desired area.

3. Get prequalified for a mortgage. Unlike a pre-approval, a pre-qualification is a non-binding estimate from the bank of how much money they will lend you to purchase a home. This is important because unless you have $250,000 sitting in a bank, you are going to need a loan to buy a house. Getting an idea of how much money you have access to will determine the size and location of the houses you consider buying. It will also help guide your real estate agent since it gives them a more accurate budget to use during the search.

Keep in mind that the amount you are prequalified for is not guaranteed. The bank could decide to give you slightly more or slightly less a few weeks later. If you’d like a binding amount, you can get “pre-approved” for a mortgage. Pre-approval is different from pre-qualification because it is a guarantee from the bank that they will loan you a set amount of money at a set interest rate. The loan amount and rate are usually “locked-in” for around 60 days.  

4. Determine your estimated costs. Just because a bank is willing to lend you a large amount of money, doesn’t necessarily mean you should take all that money. You need to come up with a preliminary mortgage amount and determine what your monthly payments would be, factoring in the average interest rate. You should also determine the difference between what you [and your partner] pay now in rent and what you [and your partner’s] homeownership costs would be. You can do this by using a mortgage calculator.

Simply enter the loan amount you will need, the interest rate estimate from the bank, and the term length (15, 20, 25, or 30-year mortgage). Doing this will allow you to see your monthly mortgage payment. Then, you’ll want to add an additional 40% to that number (so multiply your monthly mortgage payment by 1.40) to account for property taxes, homeowners’ insurance, and repairs to get an estimate of what your total monthly homeownership costs would be. If that number is higher than you [and your partner] can afford, then reset the mortgage calculator and type in a lower loan amount. Using this tool will give you a better idea of your true price range, which is oftentimes lower than the amount the bank may have given you during the pre-qualification.   


5. Write down the highest amount you are willing to spend. Shopping for homes can be a stressful process. You may fall in love with one home only to find out later it’s out of your budget. You may also find yourself in a bidding war with another buyer or with a seller who refuses to negotiate the price. Both of these situations can tempt you to pay more than you can afford for a home. In order to prevent this from happening, be diligent. Come up with a price range and write down the highest amount you are willing to spend.

Although you may have gotten prequalified for a certain loan from the bank, it’s important to come up with your own price range, within reason. Be certain that the real estate agent does not show you houses above that price. This may seem a bit obvious, but real estate agents show potential buyers houses out of their ideal price range more often than you think because the agents are paid on commission. The more expensive the home the more money they make in return. Some agents may also want to see you happy in a really nice home, but the money they make as commission is a very powerful incentive. Write down your set price and stick to it.

To summarize, there are 5 things you should do before you buy a home. Follow the steps above as you start the home-buying process.

Why I don’t plan to buy a home after graduating from medical school

 
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I’m a graduating 4th year medical student and as most physicians know, this has been one of the best years of my life. I just matched into my top choice residency and am one step closer to becoming a primary care sports medicine physician, my dream job. Many of my classmates have capitalized on this time of excitement by making the controversial decision to buy a home before they start residency. I have not. Here’s why: 

  1. I don’t have money saved for a down payment. During medical school, I was so busy completing rotations and studying for exams that I barely had time to sleep, let alone work a job. Thus, I didn’t save money for a house down payment. Although my status as a graduating medical student with a residency contract qualifies me for a physician loan, very few of these loans offer a 0% down payment and the ones that do require a higher interest rate in return.

  2. I don’t have cash for the transaction costs. Transactions costs associated with buying a home are expensive. The cost of attorney fees, escrow, home inspections, etc. add up to an estimated 3% of the entire cost of the home. Although some banks can roll these costs into your mortgage, that usually increases your monthly payment, something that may not be a wise decision for a first-year resident on a fixed income.    

  3. I don’t have an emergency fund for repairs. As a renter, if something breaks I contact my landlord and she calls someone to fix the issue. Most importantly, she pays for it. If I were to buy a home, this responsibility would fall on me. Having to coordinate repairs is not something I want to add to my plate. Plus, I haven’t had time to save money to pay for these inevitable costs and don’t want to rely on a credit card for these charges.

  4. I already have a lot of [student loan] debt.  Despite getting scholarship money, I took out student loans to help pay for my education. Like most medical students, I have over $200,000 to repay. Taking on an additional $250,000 in debt to buy a home I don’t need seems unnecessary. I need to prioritize paying off debt instead of accumulating more.

  5. Homes cost more than I can afford in my area. Many homes in the city center of Atlanta (where I will be doing my residency) cost at least $500,000. As a single person with a resident salary of only $60,000 and substantial student loan debt, I couldn’t even qualify for a mortgage that big, let alone afford one. There are cheaper homes outside of the city, but they are further away from the hospital which would add tons of traffic to my work commute.

  6. I need to save money for other things. I have other uses for the money I’d be able to save a resident. Along with paying down debt, I also need to put money into an emergency fund and save up to buy another slightly used car. Although I love my 2012 Toyota, I may need a different car in a few years. Instead of financing a new car, I’d rather save up money to purchase a slightly-used car in cash. 

  7. It won’t save me money in taxes right now. Before the Tax Cuts and Jobs Act, many young professionals bought a house and used the mortgage interest deduction to save money on taxes. Nowadays, that is much less common. Why? Because with the new tax changes, taking the standard deduction saves us more money. If I wait to buy a home as an attending, I might be able to take advantage of those tax savings.

  8. Homeownership costs are expensive and renting is cheaper. After learning about the home-buying process, I’ve realized that you cannot just compare the average rent payment to the average mortgage payment and make a decision. There are many other costs associated with buying a home in addition to monthly expenses like property taxes, homeowners insurance, and repairs that add another 40% to your monthly budget. Renting is cheaper.  

  9. My residency is only 3 years. If you live in a home for less than 5 years, there’s a good chance you will lose money in the deal, even if you sell the home for more than you bought it. Why? Because the closing costs associated with buying a home, recurring costs associated with maintaining a home, and transactions costs associated with selling a home are really expensive. It generally takes about 5 years to break even on a home when you consider these costs. Since my residency is only 3 years, there is a good chance I would lose money if I bought a home now.

  10. I’m currently single. On a more personal note, I am an unmarried female. I don’t have to be married to purchase a home, but having a spouse who works would certainly help. As a graduating medical student who has substantial debt and a resident salary for the next 3 years, purchasing a home and paying the homeownership costs by myself is a heavy load I’d rather not bear alone.

  11. I like living in the city. As a young professional, I love living in the city. Restaurants/bars are within walking distance, Uber rides to city events are affordable, and my commute to work is shorter. If I were to purchase a home, this may not be the case. Homes in the middle of the city are more expensive than I can afford as a single resident.

  12. My life may change drastically in the next few years. As an unmarried female, my life could change drastically during my time in residency. I’m no Julia Roberts, but there’s a good chance I could get married and have a child in the next 4 years. If that were to happen, the things I’d want/need in a home would be significantly different. Right now, I loathe the thought of doing yard work and prefer to live closer to the city. However, if I were married with a child I might opt for a place in the suburbs with a backyard and better schools.

My point? Although you may not have all of the same factors in your life as me, I’d venture to say that some of my reasons for not buying a house are applicable to you as well. I’m a firm believer in free choice, but I would caution any graduating medical student against buying a home at the start of residency if they share many of these things in common with me.

Of note, I published this article on KevinMD.com on March 31, 2019.

 

Adulting 101: Pros and Cons of Buying a Residential Home

 
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As a young professional establishing your career, you may start to consider buying a house. Before you make a decision on whether to buy a home or keep renting, weigh the pros and cons listed below:

Pros: Buying a home can help you….

  1. Purchase an asset that can increase your net worth. One of the perks of buying a home is that it is usually considered an “asset.” Unlike cars which depreciate or go down in value each year, homes tend to appreciate or go up in value. Clearly, things can change, as many people painfully saw during the housing market crash in 2008, but that is not the norm. Plus, even when there are rare “down years” the housing market usually recovers shortly afterwards. If you buy a home there is a fairly high chance that in a few years, that house will be worth more than you originally paid for it. As the home appreciates in value, your net worth increases.  


  2. Build equity (or value) in your own investment. Many people like the idea of owning a home. They would rather send in a monthly check towards something that is “theirs” and feel like renting is “throwing money away.” Although I disagree with this statement, I understand where they are coming from. When you rent, your money goes to the landlord and someone else uses that money to build his or her net worth. In contrast, when you buy a home, the money you pay the bank each month is used to pay off your mortgage. As you pay off your mortgage, you decrease your debt. Each payment you make to decrease your debt, decreases the percentage of the home the bank owns and increases the percentage of the home you own. Thus, you are able to increase the equity (or value) you have in the home, which again increases your net worth.


  3. Potentially save money in taxes. When you buy a home you usually take out a mortgage (aka a home loan) from the bank. As you pay off this mortgage each month, you are paying back a portion of the amount you borrowed (the principal) and the fee the bank charged you when they gave you the loan (the interest). The first few years you pay a mortgage the majority of your payment is interest. According to the tax law, you can actually deduct the part that is interest from your taxes each year which can save you money.

    Keep in mind, you can only use this tax deduction if you “itemize your taxes.” Many young professionals don’t itemize their taxes because they opt for the standard deduction which saves them even more money. My point is that buying a home has the potential to save you money on taxes if you happen to have a very high income, are already planning to purchase an expensive home, or have to itemize your taxes for some other reason.


  4. Achieve that feeling of accomplishment. Let’s face it. Many people like the idea of owning their own home. It’s a major part of the American Dream many of us want to achieve. Plus, it makes us feel like we’re finally maturing and have reached true “young professional status.” While I may not be able to quantify the “feeling of accomplishment” that comes with homeownership, its value is definitely there. If you are established in your career and plan to stay in same area for at least 5 years, homeownership is viewed as the next step and often provides internal and external validation of our life choices.

 

Cons: Unfortunately, if you buy a home you will have….

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  1. Less mobility. Unlike signing a one year lease to rent a house or an apartment, purchasing a home is more binding. When you take out a bank loan to purchase a home, you sign an agreement to pay back that loan (aka the mortgage) over 15-30 years. Although you can sell the home if you decide to leave the area, it is not as easy as you may think. In fact, most people who buy a home plan to stay in that home for at least 5 years (I talk about why that’s the case in a previous post). If you are going to stay in a home for at least 5 years you have less mobility than if you would have simply rented an apartment or a home using a one-year lease. If you change jobs or have to move to a different state, it is much easier to break a rental lease than it is to put your home back on the market and sell it in a reasonable amount of time.



  2. More debt. Perhaps the biggest disadvantage to purchasing a home is that you have to take a large loan in order to do so. The vast majority of people don’t have $300,000 lying around to spend on a home so they put down a small percentage of the purchase price (usually 3-20%) and get the rest of the money from a bank in the form of a mortgage. While there is nothing inherently wrong about getting a mortgage and making a payment each month towards it, you cannot ignore the fact that doing so puts you in a large amount of debt.

    Although a mortgage is considered “good debt” since you are purchasing an asset that can go up in value over time, you may not be in a position to do so right now. Many young professionals already have credit card debt, car payments, and a large amount of student loans they already have to pay back. Taking on another $200,000 in debt may not be ideal. Plus, the more debt you take on, the longer it will take you to pay it all back. The longer you take to pay back your debt, the more money you waste in interest payments and the harder it becomes to dig yourself out from under this pile of debt to actually build your net worth.



  3. High upfront costs- I talked about the added costs associated with buying a home in a previous post, but in case you missed it let me state it again. Buying a home is expensive. The transaction costs (or closing costs) associated with buying a home are an estimated 3% of the entire purchase price. So, if you buy a home for $250,000 expect to spend another $7,500 in transaction costs. Along with this expense, you also have to purchase furniture and appliances. Lastly, you have to factor in decor items and moving expenses. Those who rent don’t usually have to worry about the majority of these high upfront costs.



  4. Additional monthly/annual expenses. Along with high upfront costs, there are recurring expenses you must add to your monthly budget if you buy a house. Every homeowner must factor in the cost of property taxes and homeowners insurance. Some people even have homeowners association (HoA) fees they must consider as well. Plus, when you own a home you are responsible for any repairs. This means you have to put aside additional money each month to cover these inevitable costs. Altogether, the cost of property taxes, homeowners insurance, and repairs typically add another 40% to your monthly costs. For example, if your mortgage is $800 a month then you can estimate spending an additional $320 a month ($800x40%) on top of that $800, in added homeownership fees.

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To summarize, before you buy a home as a young professional, there are several things you must consider. By purchasing a home, you are able to buy an asset that increases in value and build equity in an investment that can increase your net worth. You also have the potential to save money on your tax bill while experiencing that feeling of accomplishment knowing you are making boss moves in your life. On the other hand, purchasing a home gives you less mobility in the event that you need to relocate. It also causes you to take on a large amount of debt (in the form of a mortgage), has high upfront costs, and adds additional expenses like property taxes, homeowners insurance, and repair costs to your monthly budget. Before you purchase a home it is important to consider these pros and cons to ensure you are making a sound decision.  

If you are unsure whether to buy a home or keep renting you can refer to my post “Should you buy a home or keep renting part 1 (and part 2) and use to the New York Times’ rent vs buy calculator as a guide.  





 

Should you buy a home or keep renting? Part 2: Four Practical things to consider before you buy a home

If you are like most young professionals you may be wondering if you should buy a home or keep renting. Before you make a decision, you must first consider whether or not you can afford to purchase a home. As I mentioned in “Should you buy a home or keep renting? Part 1, you cannot simply compare the average mortgage price to the average rental price and make a decision.

There are many other expenses associated with becoming a homeowner that you must consider. However, if you do determine that buying a home is a financial possibility, your next task is to determine whether or not buying a home makes practical sense at this point in your life. Here are 4 additional questions you can ask yourself to help figure that out:

  1. Are you going to stay in the same area for at least 5 years? As a general guideline, it takes about 5 years to break even on a home. If you live in a home for less than 5 years and decide to sell it afterwards, there is a good chance you will lose money overall, even if you sell the home for more than you purchased it. Why? Well, because the transaction fees you must pay to buy a home and the expenses associated with selling a home are really high.

    By the time you pay your real estate agent 3% of the purchase price, pay the buyer’s real estate agent another 3% of the purchase price, AND consider all of the costs you had when you first bought the home, there is a good chance that your expenses will still outweigh your costs until the 5 year mark. If you know you are likely to move to another area in less than 5 years, it may be wise to wait to purchase a home.

  2. Are you going to want to live in that same house (consider size and location) 5-7 years from now? The first home that many people purchase is usually a “starter” home. It typically has 3-4 bedrooms and is a decent sized space for 2-3 people. Although that type of home may be ideal for you now, you need to consider whether it will be ideal for you 5-7 years from now. You may get married, have a child or two, and even change jobs. Is the home you want to purchase now ideal for that kind of lifestyle as well?

    For example, is it a place with good school districts for your [future] kids? Is it close to your job? Does it have enough space for you, your spouse, a kid or two and a pet? The answer most people come to is: no. As a result, they end up looking for a different home, or paying a large amount of money to upgrade their current home, a few years after they purchase the "starter" home. This process of buying one home, just to sell it a few years later, and purchase something bigger can be quite expensive.

    I am not suggesting that you buy more house than you can afford to protect yourself against these life changes. However, I am stating that if there is a good chance you won’t want to stay in the home 5-7 years from now and it takes 5 years to break even on a home, it may not make practical sense to buy a house right now. Nevertheless, if you doubt you’ll experience drastic life changes in the next few years, or feel fairly confident that the type of home you want to purchase will still fit your lifestyle in a few years, then purchasing a home now might make sense.

  3. Are homes affordable in your area? Let’s face it. Not all cities are created equal. Before you get set on the idea of buying a house, you must figure out if homes are actually affordable in your area. If you are not sure, go to a website like Zillow.com or Realtor.com, type in the size of your desired home in the the city of your choice, and check out the home prices. Once you see what homes are selling for, you can then go to your bank to see how much money they are willing to lend you.

    For example, if you live in a low cost of living area like Orlando, FL the average house is probably around $240,000. Thus, there is a better chance a bank will loan you the money you need. However, if you live in a higher cost of living area like San Francisco, CA where the average house is $1.61 million then it may be difficult to find a bank willing to lend you that much money.

    In addition to cost of living, you also have to look at the neighborhood in which you plan to live. Some of the nicer neighborhoods in better school districts often charge a “Homeowners Association (HoA) fee." This is a monthly expense you give to the neighborhood that covers the cost of private parks, neighborhood events, community pools, and general upkeep. Some areas don’t charge an HoA fee, other places may demand an extra $1200 a month in these fees. Before you decide to buy a home, examine the cost of living, average home prices, and HoA fees in your desired area to see if purchasing a home is feasible.

  4. Is it a good time to buy houses in your area? Many people assume that houses appreciate in value from year to year. Unfortunately, this is not always the case. Sometimes houses go down in value. You need to examine the housing market in your area and see what the latest trends have been. Along with looking at appreciation trends, you also need to consider home pricing trends. In the real estate world we use the phrases “seller’s’ market” and “buyer’s market.” A seller’s market means that the demand for homes exceeds the number of homes available. This is bad for people looking to purchase a home because it means that houses might be selling for more than they are worth.

    In contrast, a buyers’ market means that there are more houses available than people who are looking to purchase. This is a good for people looking to buy a home because it means that houses might be selling for less than they are worth (which increases the chance that you can find a good deal). Before you decide to purchase a home, take a look at the housing market in your area. If it is a seller’s market, you may want to wait to buy a home. If it is a buyer’s market, then you may be able to find a great deal and should consider purchasing a home sooner rather than later.


My point? Even if buying a home is a viable financial option, you still need to consider if it is practical to purchase a home at this time. For starters, it usually takes about 5 years to break even on a home, even if you purchase a home and end up selling it for more than you bought it. In order to avoid losing money, you need to make sure you plan to stay in the same area for a significant amount of time. You also need to make sure that you would still want to live in a home of that size and in that location 5 years from now.
Once you determine those two things, you need to look at different housing websites and determine the average home price in your area. Are homes affordable in your desired city? Have houses been appreciating at a decent rate where you plan to buy? Is it a buyers market in which home prices are lower than normal or is it a sellers market in which home prices are higher than normal? After answering these questions, in addition to the financial questions listed in the previous post, you should be better able to decide if it makes more sense to buy a home or keep renting.

Tell me, was this post helpful? If so, what additional topics would like me to address?

Should you buy a home or keep renting? Part 1: Ten questions to ask before you decide to buy a home

 
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The real answer to the rent-vs-buy question is “it depends.” There are several advantages and disadvantages associated with buying a home. Figuring out the right choice depends on a lot of factors that are unique to your situation.

Oftentimes, young professionals who have recently finished college choose to rent an apartment. Signing a single year lease with an apartment complex gives them more mobility in case they change jobs and allows them to better enjoy the perks “city life.” As their income improves and their job stabilizes, they may begin to wonder if it is time for a change. The high amount of taxes they pay and the need for more space in a less congested area makes them strongly consider moving on to bigger and better things. They realize other people in their late 20s or early 30s are starting to purchase real estate and all of a sudden buying a home becomes the next item on the young professional “List of Things To Do to Prove You’re Finally “Adulting.”

Although the idea of buying a home makes you feel like you are progressing in life, you need to truly evaluate whether buying a home makes financial sense for you at this point in your life. You cannot simply compare the average mortgage price to the average rental price and make a decision.

Here are 10 financial questions to ask yourself before you decide to purchase a home:

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  1. Do you have money for the down payment? Buying a home is expensive. The average house in my home state of Florida is nearly $200,000. I don’t know about you, but I haven’t stacked that many coins in my piggy bank just yet. While it is true that the vast majority of people don’t pay the full price of the home when they buy it, most banks like for you to have at least 20% of the money for a home before they agree to give you the mortgage. Before you make up your mind to buy a home, you need to check your savings and make sure you have enough money to cover the down payment on a house.

    Fortunately, many banks will still allow you to purchase a home when you don’t quite have the 20% down payment. In order to do this, they make you pay something called “private mortgage insurance.” Private mortgage insurance is a small insurance policy banks make you pay in order to protect themselves. (In the event that you fail to keep up your monthly mortgage payments, the private mortgage insurance will refund the bank part of the money you owe.)

    I should mention that medical doctors have access to physician loans which allows them to buy a home with no money down and without having to purchase private mortgage insurance. Many banks have realized that doctors finish medical school with high debt burdens but still have very high incomes and rarely default on loans. As a result, they give doctors preferential treatment. If you are a physician, or will be one soon, this a great deal. However, it does not make the decision to buy a home a “no-brainer.” There are many other factors to consider. Keep reading.



  2. Have you saved enough money to cover the “transaction costs?” The process of buying a home is more than just giving the bank a down payment and securing a mortgage. There are several “transaction costs” (also known as “closing costs”) that can be quite expensive. Some examples of transaction costs are: the appraisal fee (to have a professional determine the actual value of the home), the processing fee (to have someone evaluate your loan application and prepare any other necessary documents), title insurance (to make sure that the home is actually in your name and ensure there are no problems when the seller transfers it to you), escrow fees (the third party that holds the money from the buyer and the home from the seller until all of the inspections and concessions have been completed), etc.

    Typically, these transaction costs amount to about 3% of the total price of the home. So if you are buying a home for $200,000, then expect to spend an additional $6,000 in “transaction fees.” Occasionally, banks may offer a “no-cost-closing” to certain buyers who have great credit but do not have the cash to pay for the closing. A “no-cost-closing” simply means that instead of making you come of up with $6,000 in cash for transaction fees to buy that $200,000 home, they will instead charge you a higher interest rate on the mortgage and/or add those closing costs to the total cost of the mortgage (both options usually increase your monthly payment).  



  3. Is your credit score good enough to get a decent loan? Once you have money for the down payment (or opt for a physician loan) and figure out how to cover the transaction costs, you need to make sure you can actually secure a good loan from the bank. Unless you have $200,000 lying around, you are going to need to get a mortgage from the bank in order to purchase the home. Typically, the bank loans you the money and you agree to pay them back over the next 15-30 years. However, the bank isn’t going to loan you an unlimited amount of money and the money they do loan to you will not come free. Just like the government charged you interest to take out a student loan and set a limit on the total amount of money they would let you borrow, banks charge you interest to take out a home loan and set a limit on how much money they will give you as well.

    The amount of money banks loan you and the percentage they charge you in interest for that loan is largely dependent on your credit score. I talked about credit scores in a previous post, but essentially anything over 760 is really good and you will be able to secure a mortgage with a decent interest rate. A credit score under 500 is pretty bad and you will have a hard time getting a bank to even consider your loan application. A score between 500 and 760 is on a sliding scale. The higher the credit score, the more money the bank will loan you and the lower your interest rate will be. Keep in mind, if you are married and your credit score is good but you spouse’s credit score is not (or vice versa) you may still be able to get a mortgage but the person with the better credit score may have to purchase the home is their name first (and add the spouse’s name on the title at a later date).



  4. Can you afford the monthly mortgage payment? If you have decent credit score and show a genuine interest in wanting to purchase a home, your real estate agent is going to do everything in his (or her) power to help you in this endeavor. Oftentimes, they make the home seem more affordable by pitching you on the idea that you can secure a 30-year mortgage from a bank. The benefit of 30 year mortgages is that it reduces your monthly mortgage payment (since you are paying back the loan over 30 years). The bad part about 30 year mortgages is that you end up paying tens of thousands of dollars in added interest payments over the life of the loan.

    The rule of thumb for most people seeking to become financially stable in a reasonable amount of time is to get a 15-20 year mortgage. While this saves you a ton of money in interest it increases your monthly mortgage payment. If you decide to opt for a 30 year mortgage in favor of the lower monthly payments, make sure the bank won’t charge you a “prepayment penalty” if you decide to pay off the loan sooner. Although the decision to pursue a 15, 20, 25, or even 30 year mortgage is a personal one, make sure you ask your bank what your monthly mortgage payment would be (when you factor in interest) so that you can determine if the monthly mortgage payment would be affordable.



  5. Do you have a stable job with a steady income? Because of all of these added fees, in addition to your mortgage, lenders want proof that you can truly afford to purchase a home. Before they approve your mortgage loan, they will verify your income and work status. If you are employed, they will make you verify your income by submitting W-2s, pay stubs, proof of any bonuses, and reports of any additional cash flow. If you are self-employed or own a business, they will likely ask for even more documents. If you have a good credit score, but your income appears unstable, then you may not be approved to purchase a home.



  6. How much debt do you have? Along with considering whether your income is steady, it is vital to also consider any other debt you have. For many young professionals this means taking a hard look at your existing credit card debt, car payments, and student loans. If you already have a significant amount of debt, many banks will be reluctant to lend you a couple hundred thousand more dollars for a house. The more debt you have, the bigger the chance you could have a problem paying it all back. The ideal debt to income ratio for most banks is about 35%.

    Nevertheless, there are exceptions to every rule. For example, many physicians have a lot of debt after graduating from medical school but banks will overlook this debt because their income potential is so high. While this is a great perk for physicians, it may be a financial disaster. Having nearly $200,000 in student loans and adding another $250,000 for a mortgage (in addition to all of the other home-buying expenses), isn’t exactly a recipe for financial freedom. In fact, one of the biggest wealth killers for many physicians is buying a home before they are truly able afford to one. If you are a medical student or healthcare provider you can review my post on why buying a home may not be the wisest decision right out of training here.



  7. Have you factored in the cost of property taxes and homeowners insurance? Many people assume that buying a house is much better than renting because they know friends or family members whose monthly mortgage is similar to their current rent price. They figure that if they are going to pay the same amount each month then they might as well put that money towards their own home. Although I can understand this thought process, it is flawed.

    There are other monthly/annual costs on top of the mortgage that you must consider. Two of those costs are property taxes and homeowners insurance. Unlike renting, people who own a home must pay yearly property taxes. The amount they pay in property taxes varies by state and is listed here. It ranges from 0.27% of the home value in Hawaii to 2.44% of the home value in New Jersey, with the average being around 1%. For example, if you bought a home valued at $200,000 in my home state of Florida (where property taxes are 0.98%), then you would have to pay $1,960 annually (which is an extra $163 dollars per month) in property taxes.

    Homeowners insurance (which insures your home against unforeseen damage or accidents) works in a similar way. It also varies by state and is listed here. Generally speaking, states with a high risk for natural disasters like earthquakes, floods, tornadoes and hurricanes charge the most. For example, in my home state of Florida, which has a high risk for hurricanes, homeowners insurance is the highest the country at about $3,500 a year (which is an extra $291 a month). Thus, when you factor in property taxes ($163/month) and homeowners insurance ($291/month), most people in my home state of Florida are paying an extra $454 a month IN ADDITION TO their monthly mortgage payment.



  8. Do you have an emergency fund for inevitable maintenance repairs? In addition to paying a monthly mortgage, property taxes, and homeowners insurance, there are other expenses you may have to pay for as well. The biggest of these added expenses is repairs. As you continue to live in the home your air conditioner might need fixing, the plumbing pipes might get clogged, or some other appliance could stop working as smoothly. When you are renting, the owner of the apartment complex covers these costs. When you buy a home, you pay these costs yourself. Unfortunately, these repairs can be expensive and put a serious dent in your pocket. The best way to prepare for these expenses is to set aside money each month in a “repair fund” to reserve for for future repairs and maintenance. Along with paying for repairs, you must also cover the cost of landscaping and general upkeep. These repair and maintenance expenses are not inconsequential and must be factored into your decision to purchase a home.



  9. Do you have money saved for furniture and initial expenses? As a general guideline, more space requires more furniture. Unless your parents have extra furniture lying around or franchises with Rooms-To-Go, there is a good chance you will need to purchase more furniture and other items when you first buy your home. Although you would have had to furnish an apartment if you had chosen to rent instead, homes are typically bigger and thus require more “things.” You will need bedroom and living room furniture, decor items, and costly appliances like a washer/dryer and refrigerator. Although you don’t have to purchase all of these items at once and many people host a “housewarming party” to get their friends and family to chip in, the cost of these initial items is rather large and as a homeowner you are responsible for buying most of them.



  10. Will buying a home actually save you money in taxes? If you are like many young professionals, you may be searching for ways to lower your tax rate. In fact, someone may have mentioned the “mortgage interest deduction” you can get when you buy a home. Although it is true that the mortgage interest deduction can save people money in taxes, this benefit is often overestimated. It certainly does not equate to the amount of money you pay in transactions costs, yearly fees, and added expenses when your purchase a home. Plus, it usually only benefits people who purchase really expensive homes. Let me explain.

    Whenever you pay your mortgage each month the payment includes the principal (the amount you borrowed from the bank) and interest (the fee the bank charged whey they loaned you the money). During the first few years you have a house, the portion of the mortgage that is “interest” is quite high and can often be around 75% of your entire monthly payment. The government allows you to deduct this interest from your taxable income. However, you can only take this deduction if you opt out of the standard deduction and choose to “itemize your taxes.” Most people don’t have an expensive enough house (or pay enough in mortgage interest each year) to make itemizing their taxes a good idea. Plus, even if you were able to take advantage of this tax benefit, it only saves you money at your marginal tax rate. I realize that this is starting to get a bit complicated so I will spare you the details. My point is that unless you are buying a really expensive home, the chance of you saving a lot of money in taxes each year by owning a home is low, especially with the recent changes in our tax code.

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To summarize, the decision to purchase a home should not be taken lightly. There are a ton of factors and added costs associated with buying a house that people who rent rarely have to consider. You cannot simply compare the average mortgage price to the average rent price and think you are making a sound financial decision. You have to factor in several other costs such as the down payment (although medical doctors can usually get a pass on this) and high transaction/closing costs that are 3% of the purchase price. You also have to make sure your credit score is high enough, your income in steady enough, and your debt is small enough to get approved for a loan.

Once you’ve done this leg work, you need to factor in annual property taxes (another 1% of the home price), homeowners insurance (another few hundred dollars a month), and inevitable maintenance repairs. Lastly, you should run the numbers and see what purchasing a home really costs, keeping in mind that it may not save you as much in taxes as other people may lead you to believe. After considering all of these factors, you must be honest with yourself and ask: can I truly afford to buy a home.  If the answer is yes, congratulations! If the answer is no, re-evaluate this process next year when you are in a better financial position.

My goal is not to discourage you. I just want to make sure you are aware of all of the financial costs associated with buying a home so that you can make an informed decision for you and your family.

Tell me, do you plan to buy a home or keep renting?




 

7 Main Types of Real Estate Investing

There are many ways you can get involved in real estate investing. Before you put money into a deal, you should first learn about the different types of real estate and the various ways to invest in them. While some paths require more time or result in larger profits than others, it still benefits you to familiarize yourself with different strategies so you can find the one that’s best for you. The main types of real estate investing are:

  1. Land. Yep, you read that right. Owning a patch of land or an acre of grass, is a type of “real estate” if you will. Some people purchase areas of land they believe will be profitable in the future with the hopes of making more money when they sell it for a higher value. For example, if investors suspect that developers will soon build new homes near an area of land, they might buy that land knowing that its market value will increase as the area develops and increases in value. More often than not, people inherit land, especially when a relative who owned the land passes away. When this happens, people may elect to keep this land in the family as a way to pass on wealth. Other times, people build homes or commercial buildings on the land in the hopes of creating more investment opportunities. Some real estate investors specialize in finding undervalued land and selling it to contractors or other investors for a profit.  I don’t plan to do real estate investing through the purchase and sale of raw land, but many other investors prefer this method.

  2. Single Family Homes. When I mention real estate investing with single family homes most people think I am referring to the purchase of a residential home or the renovation of an older home (similar to something they’ve seen on HGTV). As you can imagine, real estate investing is more complicated than that. For starters, the term “single family home” is what real estate investors call a house built for a single family (i.e. a 3 bedroom/2 bath house, a 4bedroom/3bathroom house, or some similar variation). To be a real estate investor with single family homes you don’t just buy a home and live in it. (Doing that simply makes you a homeowner). Real estate investors who focus on single family homes do more than that.

    They can purchase homes below market value (via a foreclosure or through savvy negotiations) and then sell them for a higher price (i.e. wholesaling). They can purchase an old home, renovate it themselves to increase its market value, then sell it to people looking to purchase a new home (i.e. Fix and Flip). They can also purchase a home, renovate it (by adding some modern appliances and newer fixes) and then refinance it with a bank (to withdraw some of the “equity” or value in the house as cash) and sell it. Lastly, people can purchase a home, rent it out to tenants, and use part of the tenants’ monthly rent check to pay off the mortgage in an effort to build wealth long term.

  3. Small Multi-family Homes. This refers to duplexes, triplexes, and quadruplexes. Single family homes are built for one family, but small multi-family homes are build for...you guessed it: multiple, smaller families. Usually, it comprises 2-4 “sets” of 2bedroom/2bathroom family homes that are all connected to each other as a single building with separate walls and doors for privacy. Investors who prefer this type of real estate usually purchase or build these small multi-family properties and rent out each unit to a different family. For example, the owner of a duplex will have two different “families” or tenants living in the building (one on Side A and the other on Side B). Each family will pay the owner a monthly rent.

    Another way investors make money from small multi-family homes is to “house hack” or live in one side and rent out the other side. For example, if a real estate investor just purchased a triplex (3-unit multi-family home), he or she may choose to live in one of the units and rent out the other two units. Many investors like this method because it allows them to purchase a property to live in and invest with simultaneously. Plus, small multifamily investing allows them to collect a large amount in total rent money (since they receive multiple checks) without having to purchase multiple homes.

  4. Large Multi-family Homes. Technically this refers to multi-family homes larger than 4 units, but usually this is just the fancy term for “apartment buildings.” Believe it or not, apartment buildings aren’t nearly as hard to invest in as people may think. Although it is unlikely that you will have the time, desire, or money to purchase an entire apartment building on your own, most of the times, people invest with others. In fact, most apartment buildings are owned by a group of people. When people decide to put their money together to invest in an apartment as a group we usually call that a “real estate syndication.”

    In real estate syndications you have general partners and limited partners. The general partners act as “active investors” and they are the people who find potential apartment buildings to purchase, evaluate the properties, and secure the financing from the bank. The limited partners act as “passive investors” and they are the people who put some of their money into the deal (along with other people) and leave all the details up to the general partners.

    Together, the general partners and limited partners invest in apartment buildings and tend to make a large profit. The details of real estate syndications can be quite complex, but essentially investors make money by purchasing undervalued apartment buildings. They then increase the value of these apartments by renovating them and raising the monthly rent. After a few years, these investors will either sell the building for a higher price or refinance it with the bank. Either way, the investors make a profit.

  5. Commercial or industrial buildings. This type of real estate typically refers to strip malls, warehouses, or commercial buildings (ie. doctor’s offices, grocery stores, etc). Investors purchase these buildings, or build them, and then rent them out to companies or business owners who need the space. It is very similar to renting out a house. Instead of your tenants being ordinary people who want the space to live in, your tenants are business owners who want the space to sell products or services to consumers.

    The lease that tenants sign to rent space in these types of buildings is for a longer period of time (multiple years) and the business owner usually takes care of most maintenance problems and repairs him or herself (instead of calling the owner of the building every time the toilet gets clogged or the lights need to be replaced). As a result, owning these buildings gives you more assurance that you will get your monthly rent regularly and requires much less hassle.

    The downside is that these buildings are expensive to purchase. Unlike apartment buildings, there aren’t nearly as many syndications available. Investors typically purchase the building on their own, or with very few partners, which may cost them several hundreds of thousands of dollars, if not millions.

  6. Real estate funds. This is when people put a certain amount of money into a large fund to invest with other people. Unlike real estate syndications, the managers of these funds use the money to invest in a variety of different real estate deals, not just one large deal. These funds are operated through companies and are officially called “real estate investment trusts (REITs).”

    Through these REITs people get to invest in more real estate deals than they would have been able to do on their own. As a result, REITs help investors diversify their investments and protect them from risk. If one real estate deal doesn’t work out, then they can count on the other deals in the fund to protect them from losing money. Many people prefer to invest in real estate using REITs because it is “passive.” You are not someone’s landlord, you do not have to do repairs or collect rent payments. You simply put your money into the REIT and let the manager of the fund handle all the details.

  7. Debt servicing. Instead of finding deals, raising money, and managing the property some investors want to be much less involved. They like the high returns and profits that can be made through real estate but loathe everything else. As a result, they may choose to work on the debt side as a private money lender or tax lien investor. A tax lien investor typically pays the property taxes on a home that someone else has failed to pay. In order to prevent the home from going into foreclosure (being seized by the bank or the state), the homeowner must return the property tax money to the tax lien investor who paid them, with interest. Thus, the tax lien investor makes a profit from paying the property taxes of someone else.

    Private money lenders, on the other hand, are investors who loan money to other people that want to purchase real estate deals. Even though many people get loans from banks, real estate deals can be expensive and banks may refuse to loan you all the money you need. For example, a bank may loan someone 70-80% of the purchase price for an investment property, but then require that person to bring in 20-30% of his/her own money. If the person doesn’t have all of the money they need, they may choose to seek a private money lender instead. Typically private money lenders are sought out by people seeking to renovate an old home and sell it within a few months. Many wealthy people prefer to be private money lenders because they can get their money back much quicker and often times they can make a much larger profit lending the money at a high interest rate than they would have made if their money just sat in a savings account.


To Summarize, there are many different types of real estate. Your first step as a real estate investor is to familiarize yourself with each of them so that you can choose the route that is best for you. You can buy land on which to build or purchase it with plans to sell it to someone else. You can focus on single family homes and seek to rent them out, purchase them wholesale (for a low price) and sell to someone else for a higher price afterwards, or fix and flip them. You can try to house-hack, rent out small multifamily deals, or instead choose to focus on apartment buildings through real estate syndications. Once you have a decent amount of money, you may want to look into commercial and industrial buildings that you can rent out to other business owners. If you want to be much more passive and invest some of the retirement money you got from your job, REITs might be good option. Lastly, you can choose to be more on the debt side and invest in real estate through the purchase of tax liens or by being a private money lender. As you can see, there are many ways to invest in real estate. These are just some of the main types. All you need to do is pick the route that best fits your goals and lifestyle.

Tell me, which route of real estate investing do you think would be best for you? What questions or concerns do you have before getting started?

Benefits of Real Estate Investing, Part 2

In addition to helping you purchase assets, increase your net worth, and lower your tax rate, real estate has other benefits as well…

  1. You can invest in it using leverage aka “other people’s money.” When you purchase real estate, either as a home to live in, or as an investment property, you don’t have to pay the full cost of it upfront.

    When people buy a home, they usually pay a small percentage of the cost as the “down payment” and then get a loan from the bank (i.e. a mortgage) to cover the rest. This method can be used in the investment world as well.

    For example, you can buy a home to rent out to family members or even buy an entire apartment building in your local city with the help of a loan from the bank. In fact, many investors fund a majority of their real estate deals using other people’s money (whether that’s money from the bank or money from investment groups, private funds, grants from local city governments, or small loans from family and friends).

    Experienced real estate investors raise money for the down payment from other rich people and then get a loan from the bank to cover the rest. By using other people’s money to fund the down payment and securing a loan from the bank to cover the rest, these investors get to own real estate properties even though they didn’t use any of their own money to purchase them. Quite a deal, if you ask me.

    Although they have to pay back these funds eventually, there are several investment strategies (like refinancing) that allow these investors to pay back that money much sooner while still keeping a big profit for themselves. You can do this too.

    Having the ability to use other people’s money to make a decent profit for yourself, and for them, is a pretty sweet deal.

    Investing in the stock market doesn’t really offer this kind of advantage. Banks, private funds, and wealthy businessmen are far more willing to loan you money for a real estate deal than for almost any other kind of investment.

  2. You can protect your assets. As you can imagine, the more money you get the more you are going to want to protect it.

    The last thing you want is to get into a car accident or make a costly mistake on your job and have someone sue you for every dollar you’ve ever earned (yes, people do this). Thus, “asset protection” or protecting your net worth from creditors and lawsuits is an area of extreme interest for wealthy people in America. Real estate can be great for that.

    Oftentimes, when people purchase a piece of real estate with the goal of making money from it, they don’t purchase it the way you would normally think.

    Instead of having money in their checking account and simply paying for all or part of it, they set up a protection entity called an LLC. The main goal of setting up an LLC and buying the property through that LLC is that it protects the value of your investments from lawsuits.

    Thus, if someone sues you personally they cannot get any money or value that is within the LLC and if one of the tenets in your property decides to sue to the apartment that is held within the LLC, he or she is not able to get any of your personal money or net worth.

    In other words, the LLC separates your personal money from your investment money, even though you are in charge of both. In fact, many rich people and smart investors set up tons of LLCs.

    For example, they may partially own 20 houses and set up a different LLC for each home. That way, if someone sues them personally or someone sues one of their LLCs, that person cannot get any of the money in any of the other properties. This type of protection is great and one of the major ways people are able to maintain wealth in their families.

  3. You have the freedom to decide how involved you want to be in the investment. You can invest in real estate “actively” and use it as a job OR you can invest in real estate “passively” in your spare time. You get to decide. It caters to everyone.

    Many of us enjoy our day jobs. We like the work we do and the impact it has on others. However, our jobs often take up a significant portion of our time and don’t leave much room for anything else, especially for those who have a spouse or kids.

    One of the things I love about real estate investing is that once you learn some investment basics, it doesn't have to take up much of your time.

    However, if you’re the opposite of me and you hate your day job entirely, there are other types of real estate investing that are more active and can be used to completely replace your old job.

    In other words, if you want to quit your job and instead make real estate your career, then you can invest actively. However, if you love your job and just want to use real estate as an additional stream of income then you can invest passively.

    Both types of investments make money, you just have to decide which side you are going to be on.

    Theoretically, the active investors put themselves in a better position to make more money (or use less of their own money in the deals) than the passive investors, but believe me, both types of investors walk away from the investments very happy (provided they found the right deals in the first place).

My point? In addition to things like extra monthly income, lower taxes, and appreciation, real estate offers several other benefits. It gives you the chance to invest using other people’s money which makes it less of a risk and a much lower financial burden for you. Real estate investing also has several entities, like an LLC, which will allow you to protect the money in your investment from lawsuits and creditors. Plus, there are so many different forms of real estate investing that you can choose how involved or uninvolved you want to be in a way that caters to your lifestyle and competing demands.

Tell me, are you considering real estate investing? Which advantage of real estate investing appeals to you most?

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