I see a version of this question posted in physician finance groups at least once a month. How much house can we afford is a common and valid concern among physicians.
We know here in the Frugal Physician community that housing costs is one of the “big three” expenses— housing, transportation, and food.
It is critical not overspend on these three categories in order to achieve financial wellness.
Housing is especially critical because it is a rather large fixed expense. Moving is emotionally and physically taxing and houses have a lot of sentimental value.
Additionally, physicians have access to no down payment, no PMI (private mortgage insurance) physician loans and jumbo loans, so there can be a lot of temptation to borrow too much and become house-poor.
Thankfully, there are a couple of rules of thumb in the financial world that can help physician families answer this question objectively.
Let’s consider the scenario of Dr. Smith’s family:
Dr. Smith, a 40-year-old physician, and his spouse, who is not employed outside the home, have a combined household income of $300,000 annually. They live in New York.
Dr. Smith currently carries $350,000 in student loan debt from medical school.
They have 2 kids.
They have 2 car loans.
They don’t have any credit card debt.
They have found their dream house and it costs $800,000 at an interest rate of 7% for a 30-year fixed mortgage.
They can put down 20% or $160,000.
Property taxes are $10,000 a year and home insurance will cost $2800. They want to know if they can afford this home.
Financial Overview
Annual household income: $300,000
Student loan debt: $350,000 (monthly payments based on the standard repayment plan)
Savings: $220,000 ($60k emergency fund + initial home down payment)
Monthly expenses:
Living expenses (utilities, groceries, etc.): $5,000
Childcare: $2,000
Discretionary spending: $1,500
Student loan payments: $3,886 (Standard 10 Year Repayment)
Car payment 1: $750 ($40,000 car note at 5%)
Car payment 2: $600 ($32,000 car note at 5%)
Retirement contributions: $23,000 yearly or $1917 monthly pre-tax contributions
Goals
Purchase a home within a desirable neighborhood that supports good school systems and amenities.
Manage student loan repayment effectively without feeling financially stretched.
Continue saving for retirement without sacrificing future financial security.
Challenges
Dr. Smith and his spouse are concerned about balancing their significant student loan debt, ongoing monthly expenses, and the desire for a high-quality home.
They’re unsure about how much house they can afford without over-leveraging their finances.
There are two ratios used by the financial industry: HR1 or the housing ratio and HR2 or debt-to-income ratio.
If a family meets HR1, they will likely qualify for a conventional mortgage at a favorable rate. HR2, in my opinion, is the more realistic when it comes to actual cash flow, especially for families a large amount of student debt.
Housing ratio 1 (HR1) is calculated as follows:
Housing costs/ Gross Pay must be less than or equal to 28%
Housing costs here include Principal payments, Interest payments, taxes, and insurance (PITI).
For this home, the numbers are as follows:
Monthly Principal + Interest payment= $4,258
Monthly Property taxes= $833
Monthly Home Insurance= $233
Total PITI= $5,325
The Smith family’s gross monthly pay is $300,000/12= $25,000
So their HR1 would be: $5235/$25,000 x100= 21%
That’s less than 28%, so they’re looking like they’re in good shape.
Let’s take a look at HR2, though, that will take into account their student loans.
HR2 is calculated as (Housing costs + Other Debt Payments)/ Gross Pay and it must be less than or equal to 36%.
Other debts included in HR2 include things like car payments, student loan payments, boat loan payments, student loan payments, credit card payments, and any other monthly recurring debt payments.
So let’s bring back the smiths family’s monthly payments:
Monthly Principal + Interest payment= $4,258
Monthly Property taxes= $833
Monthly Home Insurance= $233
Total PITI= $5,325
Student loan payments: $3,886 (Standard 10 Year Repayment)
Car payment 1: $750
Car payment 2: $600
So HR2 would be calculated as: [($5,325+ $3886+ $750 + $600)/ $25,000] x100= 42%
Oh boy, all of a sudden we’re over 36%.
All those debt payments add up.
This is why I think HR2 is a much better indicator for physicians. Some banks will not tally student loan payments into their calculations, but I don’t think that does any favors to us.
Let’s look at what the cash flow in this home would realistically look like:
In New York, their take home pay would be:
Gross Pay $25,000.00
Federal Income Tax: $3,158.02
Social Security Tax: $871.10
Medicare Tax: $400.00
State Income Tax: $2,218.75
City Income Tax: $0.00
Deductions withheld: $1,916.67
Final Monthly Pay Check: $16,435.46
Monthly expenses:
Living expenses (utilities, groceries, etc.): $5,000
Childcare: $2,000
Student loan payments: $3886 (Standard 10 Year Repayment)
Car payment 1: $750
Car payment 2: $600
Housing costs: $5325
Total mandatory expenses: $17,561
Discretionary spending= 0
Obviously, they would be living waaaay beyond their means.
Another common rule of thumb is a mortgage less than 2 times income. In this case, it would be less than a $600,000 mortgage.
That’s not that far off from $660,000 this couple is planning on borrowing.
But, as you can see, the high debt payments really hamper their cash flow with this big of a mortgage.
Plus, by maxing just one 401k at $23,000 a year, they’re only saving 7.6% of their income.
That’s much less than 10% recommended for the general public and 25% recommended for doctors.
It’s easy to see how some doctors can really dig themselves in a whole by buying too much house.
They would be much better off renting for a little bit and using some of their saved cash to pay off the cars and maybe even the student loans.
Then, they could start over, save a down payment and live freely with plenty of room in their cash flow to the desired 25% savings rate in their new home with an HR2 of 21% [($5235/ $25,000) x100.]
So, how much house CAN they afford?
I’m sure you’re getting sick of all this math. So, I’m going to point you to this nifty calculator from Nerd Wallet. Keeping the same savings rate of 7.5% (which would note be recommended), the max price of a home they could buy is $537.040.
The Smith family, should buy a house even less than that or rent for a while longer so that they can boost their savings rate up to at least 25% recommended for most physicians.
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