Decision Doctor's Bill: Is Third Time The Charm? ⋆ XRAYVSN

Johanna’s Take:

She and her family already have a vacation home in addition to their current home and they’re getting restless.

Dr. Dunker has emailed us asking if they can afford to buy a third home while converting their current house into a single-family rental.

The positives:

· Physician – moderately-high income.

The negatives:

· Relatively low savings rate considering ambitious plans.

· Still paying on student loan debt.

· Indicating would like to FIRE.

· Underfunded for children’s college.

Assumptions (I will use conservative estimates wherever there is an uncertainty.)

· 6% average long-term returns on savings (Assuming no emotional mistakes in upcoming bear markets and corrections).

· Average inflation.

· No more children.

· You have plenty of appropriate life and LTDI in place.

· No divorce.

· You invest in an appropriately-diversified portfolio and do not make any behavioral mistakes.

· No significant financial assistance for other family members.

· Reasonably good health.

· TCJA 2017 does not sunset in 2025 and current tax rates remain in effect.

20% is considered an adequate rule of thumb savings rate for physicians, but, unless your specialty generates relatively high income ($500k+) or live in a LCOL area and live on a shoe-string, early retirement is typically not on your Ouija board.

In Dr. Dunker’s case, retiring in 10 years will leave the family with some (hopefully) valuable real estate, but only ~$1.7M in investments from which to draw living expenses.

And that’s without a third house payment.

So, worst-case scenario without the third house, by retiring at age 53, Dr. Dunker will have to wait an-other 12 years to qualify for Medicare.

She will need to pay for family insurance on the marketplace during that time.

She may also need to stretch her $1.7M in retirement savings over 50+ years, which I consider highly unrealistic.

What about waiting 17 years, or until age 60, to retire?

She’ll have ~$3M at age 60, which is ~$1.8M in today’s dollars.

This is not a retirement I would plan for a client.

Here’s another consideration, though – Dr. Dunker says their living expenses are $100k currently.

Assuming they live in Denver, their effective tax rate (state, federal, FICA) currently is just under 25%.

With a 20% savings rate, a 25% tax rate, and 35.7% for living expenses ($100k/$280k), we are left with ~$54k in unallocated cash flow.

I am going to make a couple of big-arse assumptions here:

· This is their debt service on the two houses

· They have 10 years left on both mortgages.

I ran this as a little experiment and, voila, the two payments were almost exactly $54k/yr.

Just goes to show a guess is sometimes as good as a lot of number-crunching (kind of like when you try to predict interest rates or the direction of the stock market).

So, let’s say Dr. Dunker works another 17 years.

That would give the family seven years with an extra $54k to put away for retirement.

How would that work out?

Not very well.

First of all, they now have a third house payment due each month.

Even if we assume the 1st house payment is made by the new tenants, that leaves a bigger house payment in its place from the third (higher) loan.

Looking at this request from any angle, the debt is staggering considering Dr. Dunker’s income and savings level.

She already has two house payments, student loans, borrowing for a furnace and very little liquidity – and let’s don’t forget one child is starting college in three years with only $65k allocated.

Given this not-too-rosy picture, I have to give this House Hunter a…

Xrayvsn’s Take:

I am not going to lie.

This one concerned me a lot as I was reading the submission details.

Primary home with mortgage, vacation home with mortgage, and now the desire to add another property to the pile (with mortgage).

Surely this physician has a high specialty-type income and/or high net worth to even consider such a request, right?

Sadly this would be a hard No to both.

To add even more fuel to the financial dumpster fire I am witnessing, this doctor has $55k remaining on her student loans as well as a loan for the furnace (how apropos in sticking with this fire theme) coming in at $7k.

Add the listed debts and you have $517k before adding on a potential 3rd mortgage.

With a taxable brokerage account only at $25k and $475k in retirement accounts, this doctor has a lot of catching up to do if she indeed wants to retire in 10 years.

General rules of thumb regarding a home purchase is:

Keep your total mortgage at 1/3 or less of your monthly income
The home should not cost more than 2-2.5x your income.

Although I was not given the breakdown in current monthly mortgage payments as well as the projected additional mortgage payment, I am positive it would break the 1/3 rule.

Just the price of this third home by itself is already at exact upper limit of the 2nd rule (based on the income rule this doctor can afford ONE home for $700k total).

Relying on having tenants fully cover one property to keep this dream feasible is an incredibly risky proposition.

There can be unexpected vacancies and/or major maintenance issues that can prop up at inopportune times (tenants never take care of a property as well as an owner would) which could total derail this doctors financial train.

Well I’m sure the suspense has built up to a crescendo so I will not keep you on bated breath any longer….

The Decision:

Johanna: Thumbs down.

Xrayvsn: Thumbs down (and to be honest I would have thumbs down the purchase of the vacation home as well if I could have gone back in time).