How Much Does a Lawyer Need to Save for a Home?
Executive Summary
Buying a home is one of the most significant purchases in a young lawyers life. It is symbol of security and success. For lawyers who want to become homeowners, it is not a quick decision. Preparing and saving for a home can take years. To prepare yourself for buying a home, answer some relevant questions to understand your “why”, calculate how much house you can afford, and figure out the best way to save for a down payment.
Homeownership and The American Dream are tied together. Owning a home and The American Dream both represent security and success. It’s natural then for a lawyer to desire to buy a home.
Buying a home is not as easy as it once was. Rising housing prices mean a larger down payment. The high cost of law school burdens many lawyers with student loan payments that affect the ability to save. Inflation causes a higher cost of living, making it harder to save for a down payment.
Yet most lawyers have the goal of buying a home, and many would like to buy it sooner rather than later. So how much does a lawyer need to buy a home?
Initial Considerations
Buying a home is one of the most significant financial decisions a lawyer will make early in their career. A down payment alone may be more than $100,000, and a mortgage typically lasts for over 30 years. Most lawyers starting their law careers do not have $100,000 nor have they even lived for 30 years.
Lawyers should understand that buying a home is not something to rush. Take your time to save, choose the home you want to live in, and wait for the right opportunity to present itself.
Buying a home should happen after achieving two criteria: you can afford to buy the home, and you like the house. You should avoid purchasing a home when you can’t afford it but feel like you need to buy a home. You should also not buy a home if you can afford it, but you don’t like the houses available. These criteria seem simple enough, but people disregard these criteria and end up in a home they can’t afford or a home they don’t like and can’t sell without losing money.
Another important consideration is how a home’s value affects a diversified portfolio. As the Developing Financial Asset Map demonstrates, diversification gives investors the best chance of owning a top-performing asset year over year.
Let’s say a lawyer has no debt and $100,000 in diversified investments. Currently, they have a net worth of $100,000. If they buy a $500,000 house, they might use $50,000 as a down payment. Now they have $50,000 of diversified investments and a $500,000 home. The lawyer’s net worth did not increase by buying a home. Their net worth is still $100,000 because they also now have a $450,000 mortgage.
Net worth did not change, but the diversity of the investments did. Before the investment portfolio was 100% diversified, now 91% is concentrated in a single asset, the home.
There will be years where home prices exceed all or most other asset classes. There will also be years where home prices are the worst or near the bottom in asset class performance. Lawyers who understand the benefits of diversification need to account for this when buying a home.
Questions to answer before buying a home
Buying a home should not be decided quickly. It has pros and cons that lawyers need to consider before submitting an offer. Some questions lawyers should answer before buying include:
1. When would I like to buy a house?
The timeframe you set for yourself affects how much you can reasonably save for a down payment. For someone wanting to buy in the next few years, you will likely need to already be near your down payment goal. Understanding your timeline helps you determine how much to save. It also encourages you to keep an eye out for the right opportunity.
If you plan to buy in less than five years, aggressively saving is the goal. First, determine how much you need for a future down payment. Then find ways to save a portion of that amount every year. Ideally, a lawyer would have even more than they need when they try to buy because the prices of homes may increase between now and then.
2. How long do I plan to live in this home?
Are you someone ready to settle down in a location? Or are you planning to move again in the next five years or so? Do you ever want to settle in one area?
Expected time in a home makes a difference. A general rule of thumb is that a homeowner selling a house within five years is more likely to lose money on their purchase than someone who waits longer to sell. The rule of thumb may seem obvious, but closing costs and moving costs add to your total initial investment. Those extra costs plus short-term changes in home prices can affect if you break even or not.
3. Do I want a house I can move into on Day 1, or do I want to renovate it before moving in?
It’s common to love a house but not like everything about it. Some homeowners want to make renovations and updates before moving in. Renovating after moving in can be more problematic due to construction time, losing access to parts of your house during the renovation, and unexpected additional costs.
Finding a ready-to-move-in house is ideal, but it may be more expensive and harder to find. Renovating a home before moving in will cost more and also delay how long it will take to move in, leading to potentially additional rental payments in the meantime.
4. Will my family outgrow this home?
What is your idea of a first home? Is it going to be a starter home for you and maybe a roommate? Are you buying a home for a future family that has enough bedrooms and bathrooms to fit the family size you’re planning to have?
Similar to the question above, if you plan to upgrade to a larger home within five years, it may be better to wait until you can afford a larger house.
If you will have to move to a bigger home, what do you want to do with the first home? Sell it? Rent it? Are you ready to manage a rental property?
5. Can I afford this home?
How much house can you afford? Lawyers should determine a reasonable mortgage payment, given their current salary. It’s also important to consider how long you can make mortgage payments if you lose your job.
A mortgage is a 15-30 year commitment. Over 15-30 years, people will lose their jobs. Are there enough savings to cover a 3-6 month job search without losing the home to foreclosure?
Financial Preparation to Buy a House
Buying a house should not be a lawyer’s first purchase out of law school. Instead, buying a home should be planned and prepared for years in advance. From a financial perspective, there are a few things most people should have in place before buying a home. They include:
Established spending levels for a consistent cost of living
An emergency fund of 3-6 months of expenses
A good-excellent credit score
An expectation to maintain your current job for at least a few years
Debt payments that are manageable (no credit card debt)
How much to save for a home?
There are two numbers that every lawyer should know before shopping for a home: the down payment amount and the monthly housing payment. The monthly housing payment includes the mortgage, HOA fees, property taxes, and insurance. The down payment and monthly house payment are the bare minimum monthly cost. Additional costs like utilities and maintenance can add thousands of dollars to the annual expenses.
Lawyers also need to think about other costs like closing costs, renovations and replacements, new furniture and household items, and moving expenses.
How much of a down payment do I need?
Once a lawyer is prepared to buy a house, the next goal is to save up enough for a down payment. When calculating the down payment needed, a lawyer should understand the relationship between a down payment and mortgage payments.
A down payment represents the upfront investment in the house. A $500,000 home with a $50,000 down payment will need a $450,000 mortgage to purchase a house. If a lawyer has a $100,000 down payment, they will need a $400,000 mortgage to buy a home. Since a $400,000 mortgage is less than $450,000 and both are for 15 or 30 years, the monthly mortgage payment is lower for the $400,000 mortgage. So a higher down payment means a lower monthly mortgage payment. Vice versa, a low down payment means a higher monthly mortgage payment.
A lawyer needs to weigh the time to save up a larger down payment vs. the additional monthly cost of a higher monthly mortgage payment.
Another consideration lawyers should be aware of is Private Mortgage Insurance (PMI). When a homebuyer puts less than 20% down for a home, a mortgage lender will likely make the lawyer purchase and pay for PMI until the mortgage balance is 78% of the house’s value.
In the above example, a lawyer with a $50,000 down payment on a $500,000 house will have to pay PMI in addition to their higher monthly mortgage payment until the mortgage is less than 78% of the home’s value. Meanwhile, the lawyer with a $100,000 down payment will not need PMI because their down payment is 20% of the home’s value, and their monthly mortgage payment will be lower. But it likely took longer for the lawyer to save $100,000 instead of $50,000.
The average cost of PMI is typically between 0.5% - 2% of the loan amount per year. In the above example, this would mean the lawyer might have to pay between $2,250 - $9,000 extra in PMI annually until their loan no longer needs PMI. The removal of PMI can take years to achieve since some mortgages only need a 3% down payment.
So how would we calculate the down payment needed?
First, start with determining the mortgage payment a lawyer can afford. There are two general rules of thumb to consider. A mortgage should be between 2-2.5x your gross income. Second, the monthly mortgage payment should not be more than 28% of your pre-tax earnings if you don’t have student loans. If you have student loans, then the mortgage payment plus student loan payment should not exceed 36% of pre-tax income.
Note: Mortgage brokers and real estate agents may tell you that you can afford a larger house than you should buy. They are paid based on the price of the home and the size of the mortgage, so they have a conflict of interest to put you in a more expensive home. Not all real estate agents and mortgage brokers will do this, but lawyers would be wise to have a healthy dose of skepticism when determining a home price they can afford.
Example: Lorri and Anthony are both lawyers, and each earns $125,000. Together they make $250,000. They also pay $2,000 a month towards student loans. They want to buy a house but aren’t sure what mortgage amount they can afford and the down payment they will need.
Taking the above rules of thumb, they determine they can have a mortgage between $500,000 and $625,000. Their monthly mortgage payment should not exceed (36% * 250,000) / 12 months = $7,500 - $2,000 of student loans = $5,500. The $5,500 mortgage payment includes insurance, property taxes, HOA fees, and PMI, if applicable.
Using a mortgage calculator, it’s likely that these two rules of thumb don’t have the same mortgage amount. That is okay! These two rules are estimates of what kind of house is affordable. While there may be considerable differences in these amounts, a lawyer should not exceed both of these amounts.
Determining the affordability of a home needs to consider where you live, the current interest rates on a mortgage, the length of a mortgage, down payment amount, property tax rates, your credit score, and other debt payments you owe. A rule of thumb cannot account for all of these, so an affordable home price will probably fall in between these two amounts.
Because of this uncertainty, lawyers should not buy an expensive house just because it is within these two rules of thumb. Buy a home that fits you and your lifestyle. A house near the top of what you can afford is not worth buying if you don’t need a home that size. It’s okay and usually better to buy a cheaper house that you can comfortably afford rather than a home that you can barely afford. Remember that you have other goals besides buying a house.
Let’s say that Lorri and Anthony have found their ideal home costs $700,000. Can they afford this home?
It appears like it. Based on current interest rates of 3.5% on a 30-year mortgage, their payment would be less than $3,100 (well below the $5,500 maximum).
Now they must decide the down payment they will need. Lorri and Anthony have been saving for a few years now and prefer to avoid PMI. To avoid PMI, they would need 20% of the home value as a down payment. Lawyers should note that there are closing costs in addition to a down payment. The closing costs typically range between 2-5% of the home’s sale price. In this example, that would be between $14,000-$35,000.
So to avoid PMI, they will need a down payment of 20% of the home price. Their down payment, plus closing costs, will be between $155,000-$175,000. They will need a mortgage of about $560,000 - $600,000.
Since they can afford the home, and they want the house. They should feel comfortable buying this home.
How to save for a home?
For lawyers with student loan payments, it can be a difficult balance to save for a down payment while also making student loan payments. But I am here to reassure you that you can do it. And after you have your student loans paid off or forgiven, you will have a lot more money to put towards saving for a house.
If you would like to buy a home before your loans are paid off or shortly after you repay your loans, there are steps you can take to save the down payment you need. The first step is to figure out when you would ideally like to buy a house. For some people, it may be after an event like getting married or before having kids. For others, it may be in years. Maybe five years is what you think is a reasonable time to buy a house.
The easiest way to figure out how much to save for a house is to take the expected down payment and divide it by the years you have until you think you will buy a house. For a $100,000 down payment (20% of a $500,000 home), a lawyer would need to save $20,000/year to get there. This is $1,667/month. For some lawyers, this may be achievable. For others, it may not be easy to do.
Another way is to save a smaller amount of money each month than you would need in the example above but then put the money made from bonuses towards the down payment fund. For lawyers who want a home, this can be extra motivation to get the typical annual bonus plus any additional bonuses for extra billable hours. Lawyers should be aware that this strategy is riskier because bonuses are not guaranteed. Losing a year of savings because of no bonus can set a lawyer back in buying a home.
Another common question is what to do with a down payment fund. Should you invest it or keep it in a savings account? My rule of thumb is to save instead of invest, especially for lawyers who want to buy a home in 5 years or less. Investments can change in value over a short time frame, and you don’t want to save $100,000 only to see a stock market drop that leaves you with $80,000. With an appropriate investment strategy and lucky timing on market performance over a few years, a lawyer may expect to reach their down payment goal a few months earlier than expected. With bad luck in the market, a downturn in their down payment investment fund could result in years of continued savings. For most lawyers, the risk isn’t worth the potential reward.
For most lawyers, your income and savings will have an outsized impact on saving for a house than any reasonable investment strategy will.
Final Takeaways
Buying a home is a step towards achieving a lawyer’s American Dream. While it’s not for everyone, homeownership can be financially and personally rewarding.
Before buying a home, lawyers should take the right actions to ensure this purchase is a good one. These include:
Preparing financially to buy a home
Answer the questions above to better understand your why for buying a house
Determine on your own how much house you can afford
Do not rush into buying a home. Rent is not throwing away money.
It takes a while to save for a home purchase. Prioritize saving for a down payment based on how important homeownership is to you.
Buying a home is a major milestone in the Financial Life of a Lawyer. The Developing Financial Process analyzes your current financial situation, the housing market, and most importantly the home you dream of to determine how to buy it responsibly in a timeframe that makes sense for you. If you would like to learn how the Developing Financial Process can help you plan for buying a home along with other financial goals, you should schedule a free Meet & Confer. This 30-minute meeting gives you an opportunity to share the financial dreams and concerns you have. Together we will see if the Developing Financial Process can add value to your financial life.
Disclaimer: Nothing in this blog should be considered financial advice or recommendations. Your questions are unique to you and your own personal financial circumstances. You should consult with a financial professional before making a financial decision. See full blog disclaimer.