After undergrad, medical school, residency, and possibly a fellowship, it's easy to understand why most physicians and dentists are ready to establish roots and get on with life the minute your education is done. By the time you finish training, most of your peers in other professions are well into their career and family life.
The purchase of a home is often the first step doctors and dentists take to plant roots and declare that the educational years are in the past.
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BENEFITS OF A PHYSICIAN MORTGAGE
The great news is that physicians and dentists, in the eyes of most banks, are wonderful customers, especially when it comes to home loans. Doctors are considered extremely low-risk borrowers, defaulting on mortgages around 0.2% of the time. That means you are great for business at most banks.
Because of this, banks have created incentives to gain your business, especially in the form of home loans. A physician mortgage is a home loan reserved exclusively for physicians and dentists who meet specific criteria. Here are the primary benefits of a physician mortgage:
NO PMI - A significant advantage is that banks do not require physicians to purchase PMI insurance on a home loan. PMI protects the lender in the event of default on the loan, and since banks have found physicians to be reliable, that insurance is not necessary. The money you would otherwise spend on PMI can then be allocated elsewhere to increase future net worth.
IGNORE THOSE STUDENT LOANS - Speaking of student loan debt, most lenders will not hold the entirety of your medical school debt against you when offering a physician mortgage. Instead, they only factor in your minimum required payment, protecting your debt-to-income ratio.
NO DOWN PAYMENT - Another benefit is that most banks do not require a down payment for a physician loan, meaning you can take out a loan without first saving 20% of the purchase price in cash. That allows you to secure payment for your home sooner than if you were to take out a traditional loan that requires a down payment. The potential downside to this is that your mortgage is for 100% of the loan amount. So, if you purchase a home and then decide to move within a year or two of the purchase, you may have little to no equity in the property and you are not likely to see much profit, if any at all. If you're in a bad market, you may even run the risk of bringing money to closing. As you’ll read below, it is also wise to go ahead and save up the money for a downpayment, but then take out a physician loan and invest the cash.
GET A GREAT RATE, EVEN ON A JUMBO LOAN - Back in 2016, the Federal Housing Finance Agency (FHFA) increased the conforming loan limits from $417,000 to $424,100. Then, last year, the FHFA raised the loan limits from $424,100 to $453,100 for 2018. And now, the FHFA has done it again, increasing the loan limit from $453,100 to $484,350 for 2019. Therefore, anything above $484,350 will be considered a jumbo loan in 2019. Jumbo loans typically carry a much higher interest rate than traditional loans, but, when it comes to a physician mortgage, banks typically offer the same rate on jumbo loans as they offer on traditional loans.
GET A LOAN BEFORE YOU START YOUR JOB - The final benefit is that most lenders will allow you to take out a loan even before you start working, as long as you have a contract in place. Unlike more traditional loans, you will not be asked to produce several month's worth of paycheck stubs. Banks are confident that a physician with a contract will follow through on repayment. Most will normally approve if you are within 60 days of your contract start date.
WHAT’S THE DOWNSIDE?
The interest rate for a physician loan will typically be slightly higher than the standard conventional loan with a down payment. This might tempt you to put 20% down and avoid PMI through a conventional loan. However, here’s a long-term way to consider the cost of that decision.
We have inquired with banks about the interest rate difference and it is normally around .35% of 1%. When considering if it’s to your advantage to do nothing down or 20% down for the lower rate, you should ask yourself: is the interest I avoid over 10 or 15 years with the conventional loan greater than the amount of interest I would gain if I kept the cash for the 20% down payment and invested?
If you do the math, the answer is no.
For one, the interest rate for the debt is calculated based on a decreasing balance over time, whereas the interest of an investment is based on an increasing balance over time. Even if the interest rate assumptions were the same, the growth of the investment would out-pace the interest paid on the debt because in one scenario the interest is compounding, and in the other scenario it is not.
Here’s an example to illustrate the point.
Let’s assume for the sake of keeping numbers simple that you want to buy a $100,000 home. A down payment of 20% requires $20,000. If you choose the physician loan and finance 100% of the home, you keep the $20,000 and choose to invest the money in a place that could easily make a 5% rate of return each year over a 10-year period. At the end of 10 years, you would have an investment balance of $32,577, which is a gain of $12,577.
Let’s assume the physician loan is at an interest rate of 4.35% and the conventional loan is at an interest rate of 4%, both amortized over a 30-year period. Don’t forget, the physician mortgage is not only amortizing the balance at a slightly higher interest rate, but it carries a larger balance as well. At the end of 10 years, the physician loan would have a loan balance of $79,703. If you sold it for $100,000 in ten years, your equity position would be $20,297. Add the $20,297, which accounts for the interest paid during that time, and add it to the investment balance of $32,577. This gives you the total equity, which is $52,874, at the end of ten years if you choose the physician loan and invest what would have been used for the down payment.
Now, let’s assume you choose a conventional loan and make a down payment of $20,000. The loan balance would be $80,000 and at the slightly lower interest rate of 4%. In this scenario, you do not have a side fund with an invested balance because that money was used for the down payment. At the end of ten years, the loan balance is $63,027. If you sold the home for $100,000 as we did in the previous scenario, the total equity in the home is $36,973 at the end of ten years, as compared to $52,874 in equity from Scenario One.
As you can see, equity of $52,874 instead of $36,973 at the end of ten years demonstrates that a physician loan plus an investment of the cash reserved for a down payment provides $15,901 more than the conventional loan counterpart in spite of its’ lower interest rate. This is another valuable lesson in why it is so important to consider the opportunity cost when weighing the best way to repay debt.
HOW TO QUALIFY FOR A PHYSICIAN MORTGAGE
To qualify for a physician mortgage, most banks require you to have:
A FICO score of around 700 (the exact number will vary based on lender, but a strong credit score is essential)
A debt-to-income ratio of 45% or less, not including student loans. Again, this number might vary, but 45% is a realistic expectation.
Proof of a medical degree and license
A contract indicating you will start work within 60-90 days of applying for the loan
These are the basics of a physician mortgage. The details will probably vary based on the lender you choose, but overall most banks will offer the incentives mentioned above.
If you're in the market for a new home and meet all the criteria, it might be a good time to look into a physician mortgage.