Personal Finance for PhDs

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How Two PhDs Bought Their First Home in a HCOL Area in 2021

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In this episode, Emily recounts her and her husband’s home ownership journey, what she’s learned along the way about buying a home, and what she wishes they had done differently. The episode is structured around the necessary elements in your life and finances to qualify for a mortgage and purchase a home: 1) desire to buy a home, 2) income, 3) debt-to-income ratio, 4) credit score, 5) down payment and closing costs, and 6) someone willing to sell you a home. In each section, Emily speaks about the element generally and takes you through their own history to show you how all these elements finally came together in 2021 to enable the purchase of their first home.

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Introduction

Welcome to the Personal Finance for PhDs Podcast: A Higher Education in Personal Finance. I’m your host, Dr. Emily Roberts.

This is Season 8, Episode 18, and today I’m going to recount for you my and my husband’s home ownership journey, what I’ve learned along the way about buying a home, and what I wish we had done differently. I have structured this episode around what I understand as the necessary elements in your life and finances to qualify for a mortgage and purchase a home: 1) desire to buy a home, 2) income, 3) debt-to-income ratio, 4) credit score, 5) down payment and closing costs, and 6) someone willing to sell you a home. In each section, I’ll tell you about the element generally and take you through our own history to show you how all these elements finally came together in 2021 to enable the purchase of our first home.

Purchasing a home in the San Diego area has been a decade-plus-long dream for us. My biggest long-term motivator for staying on top of my personal finances was not debt freedom, not financial independence or early retirement, not lifestyle spending, but rather being able to buy a home in southern California and live a financially stable life with children.

Whenever I met people who used to live in San Diego, I asked them why they moved away, and if the answer wasn’t being transferred by the military, it was nearly invariably financial pressures. I knew it would take all of my financial skills just to make it in this high cost of living area, so that’s what I’ve been working toward all these years.

My husband and I closed on our very first home purchase in north San Diego County in April 2021. So not only did we accomplish one of our major life goals, we did it in the strongest nationwide seller’s market in recent memory.

As I tell the story of our journey to home ownership, I’m going to get really personal and transparent, which I don’t often do on this podcast. I am going to give some advice and suggestions as we go through, but please keep in mind that this episode is largely descriptive of our path, not prescriptive for yours. You will see that we’ve had privileges and opportunities that are definitely not available to everyone. COVID-19 in particular greatly influenced the end of this process, which of course we all hope will not be repeated.

I know that my story, especially the end when I start giving you numbers, will feel quite unrelatable to those of you who are still in grad school or who live in low- or medium-cost-of-living areas in the US. They certainly were for me when I was a grad student in Durham. Yet, multiple years out from finishing my PhD, here I am living it. If eventually buying a home in a high cost of living area is something you want, I hope you will find our story inspirational. If your goal is to buy a home soon, I hope you will find it educational.

If this episode raises new questions for you about the home-buying process or you’ve had some kicking around for a while, I invite you to join me and Sam Hogan for a free live Q&A call this coming Thursday, May 6, 2021. Sam is a mortgage originator specializing in graduate students and PhDs, particularly those with fellowship income. He is also an advertiser with Personal Finance for PhDs and my brother. You can register for the call at PFforPhDs.com/mortgage/.

In case you are a new listener, here is some brief biographical info so you can follow along with the episode:

My husband Kyle and I met and started dating at Harvey Mudd College, from which we graduated in 2007 at the age of 21; we both turned 22 in July 2007. Kyle started his PhD in computational biology and bioinformatics at Duke University in fall 2007; I did a postbac fellowship at the NIH for a year before starting my PhD in biomedical engineering at Duke in fall 2008. We got married in summer 2010. We defended our PhDs in summer 2014. Kyle stayed on as a postdoc in his PhD advisor’s lab for another year, while I worked a few part-time / temporary jobs while I launched Personal Finance for PhDs, which has been my main endeavor since. In summer 2015, Kyle got a job at a biotech start-up, and we moved to Seattle. We have two children, born in 2016 and 2018. In summer 2020, Kyle negotiated to work remotely permanently for the start-up, and we moved to southern California, specifically the Los Angeles area. We closed on the purchase of our very first home in North San Diego County in April 2021.

The six necessary elements to buy a home are:

  1. Desire to buy a home
  2. Income
  3. Debt-to-income ratio
  4. Credit score
  5. Down payment and closing costs, and
  6. Someone willing to sell you a home

In the rest of the episode, I’ll tell you how we checked off each of these elements and give you some pointers as well. By the way, this episode is for entertainment purposes only, and nothing in it is advice for legal, tax, or financial purposes for any individual. You are entirely responsible for your own financial decisions.

1. Desire to buy a home

Before even dipping your toe into the home-buying process, you have to actually want to buy a home. It’s not something that you can or should just fall into. And if you don’t want to buy a home, none of the rest of the elements matter.

Kyle and I do not find the idea of home ownership to be particularly attractive. We have been very happy to rent for these last 14 years in the sense that we like that our landlords have had the financial and logistical responsibility to take care of the properties we’ve lived in. We’ve never cared about not being able to customize the space we’ve lived in or anything like that. However, we did idly consider home ownership in some earlier stages of our careers.

Neither of us was in a position to buy a home financially at the start of grad school. We did know some other grad students who owned their homes in Durham, so it was perhaps feasible to buy a small home with a grad student stipend. I actually interviewed Dr. Matt Hotze, a house hacking grad student at Duke, in Season 3 Episode 3. However, anecdotally, all the grad student homeowners we knew personally had purchased their homes before the subprime mortgage crisis, no later than 2007. Lending standards were obviously a lot looser before the crisis than during and after.

The subprime mortgage crisis and the Great Recession had a very big effect on my outlook on home ownership, as I believe they have for many Millennials. The first chapter of The Psychology of Money by Morgan Housel (affiliate link—thanks for using!) discusses why individuals view money so differently from one another. The way he puts it is: “People do some crazy things with money. But no one is crazy… People from different generations, raised by different parents who earned different incomes and held different values, in different parts of the world, born into different economies, experiencing different job markets with different incentives and different degrees of luck, learn very different lessons.” His examples in the chapter of common financial experiences of various American generations include the Great Depression, high inflation in the 1970s, low inflation since the 1990s, the stock market’s high returns over the last 50 years, and the Great Recession.

Housel calls your teens and 20s “your young, impressionable years when you’re developing a base of knowledge about how the economy works.” Well, my early to mid 20s money mindset was scarred, as Housel puts it, by the housing crisis. By the time I reached my mid-20s, the mantras “Your home is not an investment” and “Don’t buy a home that you don’t plan to stay in for at least five years” had settled in deep.

Now, that five-year rule, that’s a tough one for early-career PhDs. Most of us expect to be fairly itinerant—moving cities, states, or countries for grad school, a postdoc, a first Real Job, a second, etc. You have to be really intentional as a PhD to stay in the same city for longer than 5 years, often making some kind of career sacrifice or concession to do so.

This is the dilemma that Kyle and I found ourselves in back in 2010. We had just gotten married and combined households and finances. The housing market was not strong by any means but it seemed that the worst was over. Our two grad student stipends were certainly enough to support a mortgage on a small home in Durham. We had a small amount of savings. Yet, Kyle was three years into his program and I was two years into mine. We thought, surely we will be leaving Durham by 2013, more or less. There wasn’t time, according to the 5-year rule, to have the reasonable expectation that we wouldn’t lose a bunch of money on buying and selling a home. So we didn’t buy. We focused our financial energy on retirement investing instead.

In hindsight, I learned the wrong lesson from the subprime mortgage crisis, or at least I applied a good lesson in the wrong way.

Here are a few things I’ve learned since 2010:

1) Personally, we didn’t actually move away from Durham until 2015. So we would have passed the 5-year rule anyway if we had bought shortly after getting married. The lesson there is: You might stay in your current city longer than you initially expect to. PhDs can take a long time. Keep a realistic timeline in mind in addition to an optimistic one.

2) If you own a home and then move away, you don’t have to sell it if your home hasn’t appreciated enough yet. You can rent it and become a long-distance landlord, likely with the help of a property management company. In 2012, we rented a townhouse from a private landlord through a property management company. The owner had earned her PhD at Duke and subsequently moved to Europe for a postdoc. Matt Hotze also employed this strategy when he moved away from Durham after finishing grad school.

As I record this, Scott Trench and Mindy Jensen of Bigger Pockets recently published a book titled First-Time Home Buyer: The Complete Playbook to Avoiding Rookie Mistakes (affiliate link—thanks for using!). I have not read the book yet, but I have listened to them go on the podcast rounds to promote it, and I’ve learned something just from that. One of the concepts in the book is on exit strategies from real estate purchases, namely: 1) live in it forever, 2) sell it, 3) rent it. When you buy a home, you should have more than one exit strategy that is a viable option for you.

What I want you to take from this point is that your home ownership clock does not need to stop when you move away from your current city. If it does take 5 years for your home’s rise in value to justify the transaction costs of real estate, which are very high, you don’t have to actually live in the home for all 5 years. Therefore, when you buy a home that you don’t plan on living in forever, whether that’s because of an anticipated move or growing your family or anything else, make sure that it makes financial sense as a rental as well as a primary residence.

3) Instead of relying on passive appreciation to increase your home’s value over a timeline like five years so that you can break even vs. renting, you can instead approach your primary residence with a real estate investor frame of mind. I’ve learned of two ways to do so through The House Hacking Strategy by Craig Curelop (affiliate link—thanks for using!), though there may be more.

The first method is forced appreciation, which is when you upgrade your home while you’re living in it through renovations or an addition or something similar. I don’t know how accessible that method would be to the average PhD; it’s not something that I would feel competent or confident to undertake in a cost-effective manner.

The second method is house hacking. I’ve already mentioned that term once in this episode. House hacking is when you buy a home that’s bigger than you need and rent out part of it. This could be a single family home where your tenants are your roommates or a multi-family property where your tenants are your neighbors. Assuming the ability to buy a home in the first place, I think this strategy is quite accessible for especially graduate students, who are accustomed to roommate living. I have had multiple house hacker interviewees on the podcast, including Matt Hotze, Jonathan Sun in Season 2 Episode 5, and Dr. Caitlin Kirby in Season 6 Episode 16. House hacking is an incredibly powerful strategy, which if done right can either reduce your housing expense or even eliminate it entirely and give you an additional stream of income. I discuss this strategy in depth with Sam Hogan in Season 8 Episode 4.

The upshot is that I wish I could go back in time and tell my early grad student self that living in Durham for grad school was a wonderful and rare financial opportunity. I would tell myself that buying a home with an eye toward renting it out, whether through house hacking or long-distance landlording, greatly mitigates the risk of buying in a city you don’t plan to live in forever.

That pretty well summarizes my aversion to home ownership and what I wish I had known about home ownership in my grad school years. Since I am unable to communicate with my past self, I hope you find it valuable.
In 2015, Kyle and I moved from Durham to Seattle, and that was quite a shock to our financial system. Kyle’s income jumped, of course, but suddenly our cash savings seemed pretty paltry compared to our new living expenses. Buying a home was no longer on the table. Instead, we rented a cheap apartment that was walking distance to his new job and focused our energy on growing our careers and our family. I’ll tell you more about how those years went for us financially later on in the episode.

By the time we were ready to reconsider the home ownership question in about 2018, we looked around and saw that Seattle was experiencing double-digit growth in its median home price and had been for several years. We had numerous friends buying or trying to buy in a super competitive market, doing things like waiving inspection contingencies. That didn’t sound appealing. Plus, going back to the previous discussion, we didn’t want to be in Seattle forever. I told Kyle when we moved there that I wanted to move to southern California within two to four years, and it had already been three. Instead, we decided to focus on building up a down payment on a home in California.

That brings us to the present, more or less. Home ownership was not super desirable for us in the past based on our location and mindset, but now it is. We have two big reasons for wanting to be homeowners at this stage in our life: 1) As a financially-minded person, I love the idea of, as Ric Edelmen puts it, carrying a big long mortgage. Doubly so with interest rates being as low as they are. 2) We, ideally, want to provide our children with a geographically stable home throughout their school years, which both of our sets of parents did for us. Our older child is entering kindergarten in fall 2021, so we knew we wanted to buy in 2021 if not sooner.

What I want you to take away from this section regarding whether or not you desire to become a homeowner is that you not should go on your feelings only. Your feelings matter, but purchasing a home or not purchasing a home is a big decision that should be well thought through. What are your motivations for home ownership? What are your exit strategies if you decide to buy? How can you use your home to increase your net worth, aside from passive appreciation? What are your other financial goals, and how do they rank against home ownership?

2. Income

Your income as an individual or household is one of the factors that determines the upper limit of the purchase price of your home. Income is the main sticking point keeping graduate students and postdocs from being able to buy in cities that their age-mates with Real Jobs could buy in, and that is due to the relatively low amount of income and sometimes the type of income.

First, I’ll address the type of income.

Employee or W-2 income is the easiest income type for lenders to understand and process. Basically, if you are an employee, the lender presumes that your job will continue indefinitely and that you will be able to pay your mortgage. You could potentially get a mortgage with just a single pay stub or an offer letter. Once the mortgage is close to being issued, they do check with your employer to verify that you’re not about to be let go or something similar.

Kyle has W-2 income through his job, so we knew that would be an easy sell.

Self-employment income is also common for lenders to work with, but they ask for at least two years of tax returns and profit and loss statements to ascertain whether the income is stable. Also, self-employment income will not qualify you for as large of a mortgage as an equivalent amount of W-2 income would.

I’m self-employed, and I was really concerned about how a lender would view my income. I wanted to wait to apply for a mortgage until after we filed our 2020 tax return because my income was higher in 2020 than 2018 so I thought that would help us qualify for a larger mortgage.

Fellowship income is the last income type that is common for grad students and postdocs. I hear frequently from grad students and postdocs who have been denied mortgages because the lender either doesn’t understand or can’t work with fellowship or training grant income. We’ve discussed qualifying for a mortgage with fellowship income in depth on the podcast in Season 2 Episode 5 and Season 5 Episode 17. Lenders view fellowship income as temporary, not indefinite like employee income, so they are concerned that you won’t be able to pay the mortgage after the fellowship ends. I know this sounds backwards to us because fellowship income is guaranteed over its term as long as you remain in good standing, whereas most employees can be fired at any time. However, it is possible to qualify for a mortgage with fellowship income under certain conditions and if you use a lender who is accustomed to working with it. Anyway, if after listening to the aforementioned episodes you still have some questions about whether you could get a mortgage with your particular funding situation, please come to the Q&A call on May 6th with Sam Hogan, who again is a mortgage originator specializing in fellowship income. You can register for the Q&A call at PFforPhDs.com/mortgage/.

Second, I’ll address the amount of income.

You may have heard a rule of thumb that you shouldn’t buy a home for more than three times your annual income. I learned through my own home-buying process that 3x your income is an outdated rule of thumb. Because interest rates are so low right now, people without other debt might be able to qualify for mortgages around 5x or more of their income.

The real metric that lenders go on is your debt-to-income ratio. There are actually two debt-to-income ratios, the front-end and the back-end. I’m going to address the back end debt-to-income ratio as a separate element.

Your front-end debt-to-income ratio is your total monthly housing expense divided by your gross monthly income. Your monthly housing expense includes the principal and interest payment on your mortgage, property tax, homeowner’s insurance, private mortgage insurance, and/or homeowner’s association dues. Lenders usually want your housing expense to be no more than 28% of your gross income, although depending on your loan type and credit history, some lenders might go above that number  .

Basically, this front-end debt-to-income ratio is a major factor in calculating the maximum mortgage amount you will be extended. However, what I’ve learned through my own home-buying process and my conversations with Sam is that the amount you’ll qualify for is a bit of a black box. If you want a definitive number, you’ll need to work with a mortgage broker or originator on getting pre-qualified or pre-approved.

Regarding our own homebuying journey, obviously real estate in the San Diego area is very expensive. We had to decide how much we were comfortable spending on a mortgage, regardless of the amount we qualified for, and match that up against the prices of single-family homes. There are a lot of cities and areas in San Diego County that we absolutely could not and would not buy in, and even in the remaining areas we were only looking at pretty modest homes.

When we started homing in on our target range of home prices, Kyle’s income was borderline enough to qualify for that range on its own without including mine. We were really, really fortunate when, just after we made our first offer on a house, Kyle received an unexpected and substantial raise. His income with that raise was more than enough to cover our target range. Ultimately, we went forward with his name only on our mortgage since we didn’t need to use my more complicated self-employment income.

3. Debt-to-Income Ratio

In this section, we’ll discuss the back-end debt-to-income ratio, which many people refer to as simply the debt-to-income ratio. Your back-end debt-to-income ratio is your total monthly debt payments and certain other obligations divided by your gross monthly income. The numerator is inclusive of your proposed housing expense that we delineated when discussing the front-end debt-to-income ratio.

Aside from your housing expense, the other debts and obligations included in the back-end debt-to-income ratio are the minimum payments you are required to make on credit cards, car loans, medical debt, personal loans, and child support. If your student loans are in repayment, those minimum payments go into the calculation as well. If your student loans are in deferment, your lender may consider 1% of the outstanding student loan balance as a stand-in for the monthly payment.

The maximum back-end debt-to-income ratio permitted by lenders varies widely from about 36% to sometimes over 50%, depending on the type of mortgage and the rest of your financial profile. Again, it’s a bit of a black box, so if you think your back-end debt-to-income ratio is what will limit your ability to get a mortgage of the size that you want, speak with a mortgage originator like Sam Hogan.

Kyle and I have been essentially debt-free for many years, so in our case the front-end debt-to-income ratio equals the back-end debt-to-income ratio. I bought a car at the start of grad school with a personal bank loan, but I paid that off during grad school and have since sold the car. We own one car currently, and it’s Kyle’s college car. It’s a 2003 Chevy so pretty unglamorous, but that is literally how we roll. I had student loans from undergrad that we paid off a couple of years after we finished grad school. We use credit cards, but we pay them off every month. I think we may have financed a cell phone or two at 0% instead of parting with cash, but we’re done with those payments now as well. Kyle has essentially never been in debt aside from the kind that builds your credit without costing you any money, and I haven’t taken out any new debt since I was 23.

4. Credit score

Your FICO credit score and the three major credit reports it is based on are the major ways that your lender will determine how credit-worthy you are. Basically, your credit reports and score communicate how responsible you have been with debt in the past.

If you’ve never had any kind of debt, you don’t have a credit score, and then lenders, if they even want to work with you, have to do a lot more legwork, or what’s referred to as manual underwriting, to figure out if you’re credit-worthy. That’s pretty ironic because if you’ve never taken out any debt and always paid your bills on time, you’re probably very responsible with money.

On the other hand, if you have lots of outstanding debt, that’s going to hurt your credit score.

The middle ground with debt is optimal for cultivating a high credit score, which is taking out small amounts of debt and proving that you can pay it back consistently. As your age of credit grows older, your score improves as well because that track record of on-time, in-full payments gets longer.

Exactly how a FICO credit score is calculated is proprietary, but the broad strokes are that 35% is based on your payment history, 30% is your amounts owed, 15% is the length of your credit history, 10% is your credit mix, and 10% is new credit inquiries.

Lenders use your FICO score and credit reports to determine if they’ll lend to you at all, which type of mortgage to use, and what interest rate to offer you.

If your credit score is 760 or higher, you should qualify for the best interest rates on a mortgage. The minimum credit score to get a mortgage is around 620.

While Kyle and I have never tried to hack our credit scores, you can probably tell from what I told you in the previous section that they are very good by now. I started taking out student loans at age 18 and got my first credit card at 22, so my credit history is quite long in the tooth. Kyle’s parents actually added him to one of their credit cards as an authorized user when he was a teenager, so that gave his credit score a big boost right out of the gate. Of course being debt-free at this stage while still using credit cards raises our scores quite a lot. We also haven’t applied for any new credit cards since the pandemic started, so there were no recent hard pulls on our credit reports when we applied for our mortgage. I don’t actually monitor my credit score, but Kyle keeps tabs on his through Credit Karma, and it’s been consistently over 800 for several years.

5. Down payment and closing costs

Saving up money for a down payment on a house and the closing costs on the purchase was the biggest, longest, and most intentional process we went through in preparing to buy a home. I will tell you all about it in detail after going over what this money is for and how much you should target.

First, the down payment.

The minimum down payment on a home depends on the type of mortgage you’re taking out. A conventional mortgage can require as little as 3% down, though 5% is more common as the minimum. A Federal Housing Administration or FHA loan requires 3.5% down. United States Department of Agriculture or USDA and US Department of Veteran’s Affairs or VA loans don’t have a down payment requirement.

You may be familiar with the recommendation to, if possible, put 20% down on a home. If you put down 20% on a conventional or FHA loan, you’ll avoid paying private mortgage insurance, which is an insurance premium you pay to insure your lender against the possibility of you defaulting on the loan.

The more you put down, of course, the smaller your mortgage will be. A larger down payment amount can also potentially lower the interest rate on your mortgage and make you a more competitive buyer in a seller’s market, as we have in 2021.

Second, the closing costs.

Going into the home-buying process, I had heard that sellers typically pay closing costs, but that’s not a hard-and-fast rule and it’s not all closing costs. While in a typical transaction sellers pay roughly 5 to 8% of the purchase price in closing costs, buyers pay roughly 3 to 5%. So if you were targeting a down payment size of 3 to 5%, you may want to double your savings goal to account for closing costs.

I’ll give you a history of our down payment savings over the years. But first, I want to share a memory that I have from 2012. Kyle and I were at our five-year college reunion and chatting with a friend who lived in southern California. This friend shared that she and her husband wanted to buy a home and that they were working on saving up a $100,000 down payment. A ONE HUNDRED THOUSAND DOLLAR DOWN PAYMENT. That to me was a completely unrelatable goal. She may as well have said a trillion dollars. It was totally unattainable in my world. Now, to be fair, my friend and her husband were both engineer types and I’m sure had very good salaries. And of course real estate is very expensive where they live. One hundred thousand dollars may have been a 20% down payment, or maybe not. But since I was a grad student living in Durham at the time, my mind absolutely boggled at that number.

The irony is that, nine years later, Kyle and I put down well over $100,000 on our house purchase. And I will tell you how we got there. Before I do, please recall from the beginning of the episode that I am acutely aware of the privilege that you will soon see at play in this process and that I am simply telling you what happened for us, not suggesting that you will or could take the same path.

Kyle and I opened a savings account that we nicknamed “House Down Payment” in 2014, the year that we defended. Our main financial priority prior to that point was retirement investing. By the end of grad school, we had eked our retirement savings rate up to about 17% of our gross income. We were also quite focused on budgeting and saving for irregular expenses; I shared our system for managing those in Season 7 Episode 15. Just before Kyle defended, our combined net worth had crossed $100,000, which I talk about in depth in Season 1 Episode 1.

That summer, as a defense gift, one of our sets of parents gave us $14,000. That was an incredible amount of money to us—about a quarter of our yearly household income—and completely unexpected. We decided to sequester it in the aforementioned House Down Payment account so that we wouldn’t be tempted to use it for everyday living expenses. Then, in summer 2015, that same set of parents gave us another $14,000 as a graduation gift. That also went straight into the savings account. So by the time we moved to Seattle, we had quite a nice nest egg earmarked for a future house purchase.

Once Kyle started his job at the Seattle biotech company in 2015, we reevaluated our financial goals. We increased our retirement savings rate to 20% of our gross income and have maintained it there since. The house down payment became our secondary saving goal. We figured we could move it to primary savings goal status when we had a firm timeline on buying by decreasing our retirement savings rate to perhaps 10% for a year or two. I’ll also note that we didn’t have a firm target amount of money for the down payment. We thought it would be good to have at least a 10% down payment, though 20% was likely out of reach, but of course we didn’t know yet how expensive of a house we would purchase.

I’ll give you snapshots of how the balance in that account grew or didn’t grow over the next five years.

In 2015, we consolidated some other savings we had into the account, but didn’t actively work on adding any more money to it. We got pregnant with our first child that fall, so we were instead beefing up our emergency fund and saving cash to supplement our income during Kyle’s parental leave. The balance in the account at the end of 2015 was $29k.

In 2016, after the birth of our first child, we committed to contributing a certain percentage of my irregular at that time income to the account, which amounted to tens of or a couple of hundred dollars per month. The balance in the account at the end of 2016 was $31k.

We continued that savings plan into 2017, and I even started paying myself a regular salary from the business. When we got pregnant with our second child that fall, we switched our savings goal as we did for our first pregnancy and temporarily stopped contributing to the account. The balance in the account at the end of 2017 was $40k.

In 2018, our insurance changed halfway through our second pregnancy. We were responsible for more medical bills associated with the birth of our second child than we had with our first, plus we supplemented our income during Kyle’s parental leave again. We returned to our savings plan after the birth of our second child, but then decided to pull money back out of the account for some of the medical bills and other irregular expenses. The balance in the account at the end of 2018 was $39k.

Through 2019, we continued to save a certain percentage of my income into the account, and we layered in an additional fixed $250 per month. Again, around tax time we contributed to the account a portion of a distribution from my business and our self-tax refund, which amounted to approximately $10,000. (Sidebar: We save a generous amount from each of my paychecks into a separate savings account earmarked for income and self-employment tax. We pay quarterly estimated tax and also more along with our tax return. Our self-tax refund is whatever is left over in our savings account after all the taxes are paid, which we then incorporate into the rest of our finances.) The balance in the account at the end of 2019 was $56k.

2020, as you all know, started out normally. We again were saving a couple of hundred dollars each month, plus a bolus around tax time. Then, the pandemic hit. We stopped paying for childcare, which was certainly a strain on our time and stress levels, but did allow us to increase our monthly savings rate to the down payment fund to $1,500. We also put most of the first stimulus check into the account.

I’m sure everyone has struggled during the pandemic in at least one facet of life. Our primary struggle was as the working parents of very small children. Both of our children’s preschools and our babysitting service closed. We had no nearby family, and all our nearby friends were dealing with their own small children. I’m sure you’ve heard that “it takes a village” to raise children. Well, the village was gone—or only on Zoom, at any rate. We definitely had it easier than many because of the flexibility in my schedule, but that only goes so far.

By the summer, when we acknowledged this was not just a flash in the pan, we realized that nothing was actually keeping us in Seattle. Kyle negotiated for permanent remote work with his employer, and we started preparing to move to southern California. Our Plan A was to rent a single family house in one of the cities in San Diego County that we were considering buying in so that we could get to know the area. As our desired move date grew closer, we were having some difficulty arranging for a rental at a distance, and we decided to exercise Plan B, which was to move in with Kyle’s parents in the Los Angeles area. They had extended us an open-ended invitation to stay with them.

That’s how, in August 2020, we moved back in with our parents, kids in tow. And even though it wasn’t what we thought we wanted, it was exactly what we needed. I’ve been calling these last eight months a time of respite. We were so tired and so stressed. Moving in with Kyle’s parents has benefited us in so many dimensions. They have provided part-time childcare throughout this period, which relieved so much of the time pressure we were experiencing. Kyle and I could leave the house together without the kids, which was incredible, especially once we started house hunting in earnest. Our kids had two more people they got to interact with on a daily basis.

On the financial side, Kyle’s parents refused any payment for living expenses, not rent, not utilities. Our only financial contribution to the household was to take over the majority of the grocery spending. Therefore, starting in September 2020, we increased our monthly savings rate into our down payment savings account to $4-5k. The balance in the account at the end of 2020 was $115k.

That saving rate continued at the start of 2021. We also put the second and third rounds of stimulus that we received into the account. When our respective sets of parents saw that we actually started house hunting, they also gave us a combined total of $86k. That a lot lot lot of money. We were not expecting or counting on those gifts at all. We are obviously really grateful to our parents for passing those on to us. The addition of those gifts put us well over the 20% down payment plus closing costs target, and we even have enough left over to do some needed repairs and upgrades to the property we bought. We’ll get into that momentarily.

Before we move on from this section, I want to point out some advice or observations:

1) I think it was psychologically important to us that we had a named savings account open for our down payment. Having a certain place to house money for any particular goal keeps it front of mind and prevents you from mixing money intended for that goal with your other money.

2) It was a good step to have a set savings rate going into that account on a monthly basis, when we did, and also to know that we would put any financial windfalls, like our self-tax refund, into that account.

3) Living rent-free with family members is an very, powerful financial move if it’s agreeable among all parties. We wouldn’t have done it if not for the pandemic, but I’m really grateful that we had the opportunity.

4) If you suspect your family might be planning to gift you money for your down payment, I suggest trying to find a way to get that conversation started earlier rather than later. You can tell from our tally that over half of our down payment fund was sourced from gifts, most of which we didn’t know about until the eleventh hour. We could have done more optimal financial planning if we had known they were going to arrive. Then again, it does feel good that we had some skin in the game.

5) Speaking of optimal financial planning, I’m not thrilled that we had cash sitting around since 2014 waiting for us to buy a house when in hindsight it could have been invested. Throughout this whole period, we sort of continually thought that buying a home was about two years off. For a two-year time horizon, cash makes the most sense. But that two years was actually up to seven years in our case. I am glad that we maintained our 20% retirement savings rate, because at least that money benefitted from the incredible market returns in recent years.

So my suggestion is to not skimp out on your retirement savings unless you have a really firm timeline on when you’ll buy. You might even invest part of your down payment fund if you are confident that you have time to weather any market downturns. We knew that we would be able to remove our contributions to our Roth IRAs and even some of the earnings if we really wanted to use them for a home purchase, so that helped us feel comfortable with a relatively high retirement savings rate.

You can see why I said at the beginning that this is a descriptive rather than prescriptive tale, right? Generating down payment money by receiving gifts from family, putting away thousands of dollars sent by the federal government for aid, moving in with your parents, and forgoing childcare is not exactly replicable.

6) Someone Willing to Sell You a Home

This last section is the story of how we bought a house in 2021, the strongest nationwide seller’s market in recent memory.

Once we moved to CA in August 2020, we saved a few searches on real estate websites that pull from the Multiple Listings Service and started passively figuring out in what areas of North San Diego County we could buy a single family home in our price range. We narrowed down our search to about 5 cities/areas. We also compiled a short list of must-have and nice-to-have features of our future home and property. That fall, we worked on making sure that the financial items I talked about earlier in the episode were all in order.

I read Home Buying for Dummies that fall to put together a game plan for getting a real estate agent and lender and so forth. Because at that time we thought we might need my income to qualify for a mortgage of the size we wanted, we agreed to file our 2020 tax return ASAP in January 2021 so that we could give that to our lender. In December and January, we also started contacting local real estate agents with the plan to interview several before choosing one.

That plan went completely out the window when we saw a property pop up in our search in mid-January. By that time, we were primarily using Redfin because we liked its search functionality best. So we saw this property come up in our search that met everything on our list and was well below the maximum of our price range. During the pandemic in California, there are no open houses, and you need a real estate agent to book a private appointment to see anything. We didn’t have an agent yet. Redfin, however, anticipates this exact situation, and so has a feature where you can request to see any property and you’ll be assigned a Redfin agent to go with you. So we did that. We also got a quick prequalification letter from the mortgage arm of our bank, Ally, for the amount we would need.

I’ll spare you the blow-by-blow, but we did end up putting in an offer on that house. The home’s list price was $675,000. Our offer was for $726,000. It sold for $746,000.

It’s very, very involved to decide whether you want to buy a particular house and put together an offer, especially a first offer, so we were working closely with the Redfin agent through that process. Ultimately, we decided that we liked working with her and she was doing a good job, and that’s how she became our agent. So that aspect of Redfin’s business model totally worked on us.

I want to take a small sidebar here about Redfin and why we liked working with one of their agents. Since we didn’t work with any agents outside of Redfin, these perks may exist elsewhere, too, so I’m not saying they are exclusive. 1) Redfin’s search engine is really nice to work with, definitely our favorite, and their app is good, too. 2) It’s seamless to view a property on the website or app and communicate with either your co-buyer or your agent. 3) Redfin takes a smaller-than-standard commission on the buy side, and the difference is refunded to the buyer at closing. 4) Our Redfin agent was on salary, so she got paid whether we bought a particular house or not. We didn’t like the commission-based compensation model of traditional real estate agents because it misaligns the incentives of the agent and buyer, so we felt much more comfortable with Redfin’s salary model. 5) If our agent was ever unavailable to tour a home with us, Redfin assigned another agent to sub in. So we never missed out on seeing a home because of our agent’s schedule.

So our first offer wasn’t accepted. But what we learned from that offer is the power of the appraisal contingency waiver in this market.

There are several contingencies in place in a standard home purchase offer that are in effect once the offer has been accepted and the house goes under contract. A contingency is a way for the buyer to back out of the deal if the contingency is not fulfilled. If you’ve talked with people going through the home-buying process before, you’ve probably heard about the inspection contingency. Once you go under contract on a house, there will be an inspection that will probably turn up a bunch of things wrong with the house. This is a chance for renegotiation, such as asking the seller to make certain repairs or give the buyer money at closing to make the repairs. If that negotiation does not go the way the buyer wants it to, the buyer can exercise the inspection contingency and get out of the contract without penalty, or even do so without negotiating. There are numerous contingencies that are standard for a contract, including the inspection, financing, and appraisal.

So that’s how contingencies work once you’re under contract. When you make an offer, in a strong seller’s market it’s common to waive as many of the contingencies as the buyer is able to and comfortable with. In our case, we could not waive the financing contingency because we were using a mortgage to buy the home. We would not waive the inspection contingency, and the market wasn’t quite strong enough to make that a common tactic. One of the reasons we lost out on that first offer was that we did not waive the appraisal contingency, whereas the winning offer did.

So what is the appraisal contingency? The buyer and seller agree on a price for the home, and during the contract period the home is appraised, which means that it is assessed by a professional and assigned a value that it could be sold for. In a not super hot market, this value is typically at or above the agreed-upon sales price, and everyone is happy. In a rapidly rising market, like we’ve seen this year, it’s typical for the agreed-upon sales price to be above the appraisal. That becomes a problem if you’re using financing, because the bank will usually not lend you more than its assigned fraction of the appraisal value.

To use round numbers, let’s say that you go under contract on a home for $220,000. You were planning to put down 20%, which is $44,000. But the appraisal comes back at $200,000. Your lender is going to say, nope, we are going to lend you 80% of $200,000, which is $160,000, not 80% of $220,000. Your choices at that point are to 1) get another appraisal that you hope comes back higher, 2) bring to the table $60,000 in cash to make up for the appraisal shortfall, 3) decide to redistribute your cash to fully cover the appraisal shortfall and instead put down less than 20%, or 4) exercise your appraisal contingency to get out of the contract if the seller doesn’t renegotiate the purchase price.

Now, it is apparently possible in some cases for the lender to give the buyer the go-ahead to waive the appraisal contingency with the agreement that the lender will still put up their agreed-upon percentage of the sale price, no matter how high the price goes. Our lender did not agree to that.

In our experience in the San Diego housing market in 2021, appraisal waivers are commonly used, and when multiple offers are in play, it’s likely that the seller will pick one that has this particular waiver. We didn’t use an appraisal waiver in that first offer, but we did in our second and third offers.

Speaking as a layperson and first-time homebuyer, waiving the appraisal contingency really scared me. Not only am I coming to the table with my 20% down payment plus closing costs, but now I have to potentially bring even more cash to the table just to make the deal go through, and that cash is above and beyond what an unbiased professional thinks the home is worth. And there’s no real upper limit to how much cash you could be asked to bring because you won’t know for sure what the house appraises for until you’re under contract. Suddenly the cash that we had saved and been given that far exceeded our projected 20% down payment seemed like it might not be enough.

Our agent and lender reassured me that even if we waived the appraisal contingency, we could still get out of any contract that we go into on the financing contingency. Apparently they are somewhat redundant. If the appraisal comes in lower than we expected and we didn’t want the house any longer, we could ask our lender to say they won’t lend to us the needed amount and use the financing contingency to cancel the deal. Of course, nobody wants a deal to be canceled in this way, so Kyle and I had to decide for each of our subsequent offers where we used an appraisal contingency waiver how much of an appraisal shortfall we were willing to make up with cash and consequently how low the appraisal would have to come in for us to exercise the financing contingency.

The second house we put in an offer on was listed at $769,000. Our offer, assuming the escalation clause was exercised, was for $860,000. That house received 21 offers, and the seller’s agent counted with 7 of the them, including us. He asked for certain changes to everyone’s contracts and to submit our highest and best offer, no more escalation clauses. We stuck with $860,000. The house sold for $861,000. It turns out that the winning buyer agreed to “beat any other offer,” and retained a tacit escalation clause following the counterofferr. That one was a heartbreaker.

The third house we put in an offer on was listed at $675,000. Our offer was for $746,000 with an escalation clause up to $756,000. The winning offer was all cash for $730,000.

At that point, we were totally emotionally exhausted. We had toured 13 homes and made 3 offers. Each one was completely wrenching for us. Quick decision making is not our strong suit, but it is necessary in a fast-moving market. Typically homes would be listed between Tuesday and Friday. We would tour them on Saturday, usually, and then have to submit an offer by Sunday or Monday. Each tour day involved at least 90 minutes of driving each way between LA and SD plus more driving to each of the homes. Every week and weekend were consumed with this process, and we were getting tired.

Remember that list of must-haves and nice-to-haves from before we started the search process? It had about tripled in length by that point. Touring houses and making decisions about whether or not to make offers really helped us clarify what we were looking for. We were able to become much more specific about our search parameters and could better decide based on a listing whether it was worth it to tour a home. We had also increased the top end of our price range by about $150,000.

On our last weekend of touring, we saw six houses on Saturday! Even though we had gotten a lot more specific about what we wanted, those six all made the cut. We noticed while we were out that there were way fewer buyers around than there had been on other weekends. Usually, we would show up for a 15- or 30-minute appointment and there would be someone finishing up their appointment just as ours was starting or would be waiting for ours to finish, often both. Sometimes, houses would be 100% booked for showings. However, that weekend, we had several appointments where no one was seeing the house immediately before or after us. It was a very noticeable aberration.

That was a very long day and very long weekend. After seeing the six homes, we only immediately ruled out one, so we debated putting in an offer on any of the other five. We slowly whittled down the list until we had just one remaining, but we simply didn’t feel strongly enough about it to put in an offer. We were very disappointed that we weren’t seizing our opportunity to make an offer on the low-volume weekend, but we just couldn’t do it by the end of the day on Sunday.

All day on Monday, we wondered if we had made a mistake by not making an offer on that last-to-be-ruled-out house in particular. On Tuesday, when the houses that went under contract over the weekend change their status to ‘pending,’ we saw that house’s status changed to ‘back on the market.’ We immediately contacted our agent, who told us that she had spoken with the listing agent and that the house had not received any offers. We knew this was our second chance and we moved fast. We put in an offer for below list price that day. We didn’t waive any contingencies because we knew we we weren’t competing with any other buyers. The sellers countered for asking price, and we went under contract for $700,000.

Kyle and I have speculated about why we got this house for asking price, which the house also appraised for, when virtually all the other ones we were interested sold for so far above asking and appraisal. I know we got lucky, but maybe our luck could be strategy for someone else. The following are some pieces of maybe advice for a hot market.

1) We stayed in and kept pounding the pavement. Even though we were tired, we didn’t take a break, we just refined our process.

2) Because we were out there just about every weekend, we recognized that weird low-volume weekend as an outlier and our chance to win a bid with less competition than usual.

3) We overlooked our house’s poor showing. I honestly think the listing agent made a major strategic blunder by listing when she did, which we benefitted from. The house was renter-occupied when it was listed, which meant 1) it was only shown for four hours total that weekend and 2) the house was not empty or staged, but rather cluttered with the renters’ possessions. The garage and living room were all but inaccessible due to the volume of stuff crammed into them. The windows were covered with a thick tinting film, so the house appeared very dark. It had a strong smell from the renters’ cooking. Finally, there was a necessary and obvious repair that had been neglected by the owner. The house apparently did not make a good first impression on the limited number of people who were able to see it that weekend, which resulted in there being no offers until we changed our minds. If the agent had waited to list until the renters had moved out, which they did a couple of weeks later, I think the sellers would have had a completely different result. On our end, none of the items that I just listed were the reasons we initially passed on the house. We really were able to overlook those cosmetic issues and focus on the fundamental attributes of the house.

The next month, between going under contract and closing on the house, is not something I hear people talk about as much as the first stage. It’s not as thrilling as house hunting, but a lot more work get done. I definitely developed a new appreciation for our agent. There is a lot of communication, negotiation, and paperwork, and we were really glad to have a professional guiding the process as well as support from numerous other professionals. On our side, we almost pulled out of the deal like three more times as new information came to light, but we ultimately decided to stick with it, and we now officially own that house.

My advice for you on finding someone willing to sell you a house is:

1) Start early figuring out where you want to live. Research your market thoroughly months or years in advance of when you actually want to start house hunting. You can do this through tracking prices, visiting the various target areas, and talking with people who live there. Ideally, you would actually live there for a while before buying. We wish we had been able to do this.

2) In non-pandemic times, I suggest going to a lot of open houses. I think we would have really benefitted from a period of casually seeing houses in person to expand and refine our list of must-haves and nice-to-haves. For example, a big difference for us between simply visiting someone’s home and evaluating whether or not we wanted to buy it is that in the latter case we brought a range finder to measure distances and calculate square footages. We developed opinions on how large a bedroom or a dining area or a backyard should be for our home that we didn’t have prior to starting house hunting.

3) Interview real estate agents. I am happy with the agent we worked with, but I’m not happy about how we sort of defaulted into working with her. And do consider Redfin. We had a great experience with the company.

4) Shop around for a loan, again well in advance of when you make your first offer. On our agent’s suggestion, we worked with a local mortgage broker, which was a great experience. But we also got our own quotes from several lenders and even one other broker to make sure we were getting the best rate. A piece of advice I got from Sam Hogan was to ask each potential lender for the official loan estimate. Quotes can take on any format, so a potential lender might be able to make theirs look more attractive by omitting or shifting around some of their fees. Loan estimates have a consistent formatting across the industry, so it’s actually possible to compare them directly.

5) Once you’re ready to submit offers, as I said earlier, pound the pavement consistently because you never know when conditions will align for you to get an offer accepted, like in our case.

6) Trust your agent, or rather find an agent that you can trust. Our agent was not super directive in telling us how much we should bid on a particular house, but she did provide us with information and market insights and to help us make the decisions. She helped us respond to shifting market conditions, like starting to use the appraisal contingency waiver.

Conclusion

We’ve come to the end of the episode! I hope this gave you some insight into what it takes to buy a home, particularly in a HCOL area in a strong seller’s market. Please know, however, that it is often possible to buy a home without all of the advantages that we had. Our financial profile is quite strong at this point because of our age, post-PhD incomes, and the gifts we received, but if you don’t have those things going for you, you may still be able to buy a home. Of course, that depends a whole lot on where you’re trying to buy. In fact, buying a home at an early age could put you in an even stronger financial position by your mid-30s than we are in, especially if you house hack or force appreciation in your home.

Best of luck to you in your home-buying journey! Sam Hogan and I will be answering any question you have about being a first-time homebuyer as a grad student or PhD this coming Thursday, May 6, 2021. Register for the call at PFforPhDs.com/mortgage/. Please join us!