You’re a 30-year-old resident physician. You’ve decided that you no longer want to rent an apartment and that it makes more financial sense to become a homeowner. Congratulations! Owning a home is a big milestone! Except… you don’t have $80k saved up for a down payment…and you’re $300k in debt… and you only made $68k last year…. AND your credit score is lower than your STEP 3 score. Who’s going to loan you money to buy a house? How does any resident who isn’t independently wealthy ever own a home?
The physician mortgage loan
A physician mortgage loan is a mortgage specifically for medical professionals. They benefit those who are just beginning their careers such as medical students, resident physicians, fellows, and new attending physicians.
Physicians have a disadvantage in that they have years of extra schooling and training. While your college friends were out in the workforce advancing their careers, you were still in school studying anatomy and biochemistry. While they were paying off their college loans, starting families, and saving for retirement, you were learning how to put in Tylenol orders. This is years of income, savings, investing, and appreciation of assets that have been deferred during the pursuit of a career in medicine.
In addition, most of us have student loan debt that is slowly collecting interest in the background. According to the AAMC, the median four-year cost of attendance is $250,222 at a public medical school and $330,180 at a private medical school. Interest rates for student loans are as high as 6.28% for federal Direct PLUS loans, or even up to 12% for some private loans. All of this is compounded by the reality that many physicians are only making minimum income-based repayments which results in loans snowballing in size over time.
These factors result in many physicians having a high debt burden with low income or few assets, making it difficult for physicians to qualify for traditional mortgages. However, it’s no secret that physicians will likely have a high paying job soon (see Dr. Watson’s post on HENRY’s), and that even though we have a large amount of debt, we tend to be at low risk of defaulting. Physician mortgage loans take into account the unique circumstances of early medical professionals who, in other circumstances, would not qualify for a conventional mortgage.
How do conventional mortgages work?
Conventional mortgage loans fall under either conforming loans or non-conforming loans. Conforming loans are mortgages that fall under a certain dollar limit set by the Federal Housing Finance Agency (usually $548,250). Conforming loans also meet other guidelines set by Fannie Mae and Freddie Mac, which are government-sponsored entities which purchase mortgages from your mortgage lender so they have free cash to lend out again. Non-conforming loans exceed the limits or do not meet the above requirements.
Conventional loans typically require a down payment which is an upfront amount that you have to pay, often expressed as a percentage of the price of a large purchase (eg. for an $800,000 house, a down payment of 10% would require you to pay $80,000 up front). The average down payment on all home purchases is about 12%, but they can be as low as 3% for first-time home buyers.
A larger down payment means your lender has to loan you less money and, ultimately, means you represent a lower risk to your lender (as you have less to pay back). Putting less than a 20% down payment on a house typically means you have to pay a private mortgage insurance (PMI) on top of your monthly loan payments. A PMI is a type of insurance that protects the lender against you defaulting on your mortgage payments. PMI costs can range from 0.25% to 2% of your loan balance per year depending on the size of your down payment, your credit score, loan term, loan size, and interest rate. This is not an insignificant amount of money – for example PMI on a $750,000 house can cost you $7,500 every year. You can expect to pay for PMI until your equity in your house reaches a loan-to-value (LTV) ratio of 80% (loan amount / appraised value of the home). Your lender is federally required to automatically cancel your PMI once your LTV reaches 78%.
In most cases, you’ll need a credit score of at least 620 and a debt-to-income ratio (DTI) of 50% or less to qualify for a conventional loan. You can check your credit score using free online services such as AnnualCreditReport.com. Your DTI can be calculated by adding up the required recurring minimum monthly payments (eg. minimum required payments for rent/mortgage, auto loans, credit cards, personal loans, student loans, property taxes etc.) and dividing it by your gross monthly income.
Advantages
The main advantage of a physician mortgage loan is that they will finance your loan with 0% down payment without requiring you to pay a PMI. Not having to save up a lump sum of money allows you to put the money to use elsewhere, such as investing or paying down higher-interest debt (student loans, car loans, etc).
Physician mortgage loans have looser financial requirements to qualify. Most lenders will allow you to have a higher debt-to-income ratio because they know new doctors often have a large debt burden. Traditional mortgages include student loans in your monthly debt payments when calculating DTI while physician mortgages do not. Traditional lenders will typically want to see a two-year history of income to qualify you for a conventional loan. However with physician loans, they will accept employment contracts or offer letters rather than pay stubs as proof of employment.
Finally, physician loans will have higher limits than conventional loans, typically $1 million for 95-100% financing, or $2 million for 90% financing. This will allow you to purchase a larger or pricier house than you would otherwise be able to afford.
Disadvantages
The main disadvantage is that the interest rates for physician mortgage loans tend to be higher than your conventional loans (0.125-0.25% higher). Over the lifetime of a 30-year mortgage, this can add up significantly and will end up being much costlier than a conventional loan.
In addition, taking a larger loan without the requirement of a down payment means your principal has the potential to be much larger. This results in a relatively high monthly loan payment and can be difficult to manage if living on a tight budget. Physician loans are also adjustable rate mortgages as opposed to fixed-rate mortgages, which means that interest rates can fluctuate and will often increase. A sudden rise in your interest rate can be problematic if it comes unexpectedly and isn’t properly budgeted for.
A high interest rate also puts you at a higher risk of developing an “underwater mortgage”. If the value of your home decreases during a market downturn, this will result in a loan with a higher principal than the home is actually worth.
Physician mortgage loans are also limited in the type of home you can purchase. They can only be used for your primary residence. Other properties such as vacation homes, second homes, condos, and townhouses may not qualify. You also cannot get a physician loan to buy an investment property.
Should I get a physician mortgage loan?
Just because you have the ability to take out a physician mortgage, it doesn’t mean that you should. Ultimately, it depends on your financial situation, your future career goals, and how much you value owning a home.
If you are in no rush to buy a home, one option is to save up some money for a 20% down payment and apply for a conventional loan when you are more financially secure. After all, if you have student loans and no money for a down payment, it might not be the wisest choice to take on even more debt to buy a house. In addition, if you save enough for a 20% down payment, you can forego the PMI when taking out a conventional loan. It is important to remember that a physician mortgage loan will cost you more over the life of the mortgage than a conventional one. This is the only reason that lenders are willing to offer this product to us!
You might discover mid-residency that you want to sub-specialize in a field that requires you to do a fellowship, or you find an attending job after 3-5 years of residency that is in another city, requiring you to ultimately move anyway. It costs an estimated 5% of the value of the home to buy it (closing costs, inspection fees, appraisal fees, title searches, loan origination fees) and about 10% to sell (more fees, cost of fixing up the house, commissions, etc) so you would have to wait for your home to appreciate at least 15% just to break even.
One may decide to take out a physician mortgage loan with the intent to later refinance into a lower rate conventional mortgage. Refinancing refers to replacing your current mortgage with a new one, usually to reduce your monthly payments or to lower your interest rate. Similarly to buying and selling a home, refinancing also costs money, including origination fees, home appraisal fees, etc. This could cost you 2% to 6% of the total loan amount, so the difference in interest rates when refinancing will have to be significant enough to offset these costs for it to be financially worthwhile.
There are also other mortgage options available. For example, FHA loans which are backed by the Federal Housing Administration, have less strict requirements than conventional loans. If you are a military service member, you may qualify for a VA loan which does not require you to put a down payment or pay PMI. Furthermore, they tend to have lower interest rates than physician loans, however, also with lower lending limits. If you plan on buying a home in a rural area, you may qualify for a USDA loan offered by the U.S. Department of Agriculture which also requires no down payment.
In conclusion, a physician mortgages loan is a unique product offered to medical professionals that may allow you to buy a home earlier in your career. However, it will likely come at a higher cost in the long run. It is one option available among many others, but in the end depends on your financial situation and personal values.
References
[1] Dahle, JM. The White Coat Investor. 1st ed. USA: The White Coat Investor, LLC; 2014.
[2] Physician Mortgage Loans. The White Coat Investor. https://www.whitecoatinvestor.com/personal-finance/the-doctor-mortgage-loan/. Accessed December 30, 2021.
[3] Youngclaus J, Fresne JA. Physician Education Debt and the Cost to Attend Medical School: 2020 Update. Washington, DC: AAMC; 2020. https://store.aamc.org/downloadable/download/sample/sample_id/368/
[4] Grad PLUS Loans. Federal Student Aid. https://studentaid.gov/understand-aid/types/loans/plus/grad. Accessed December 30, 2021.
[5] What Is A Conventional Loan? Rocket Mortgage. https://www.rocketmortgage.com/learn/conventional-mortgage. Published January 26, 2002. Accessed February 9, 2022.
[6] 2021 Home Buyers and Sellers Generational Trends Report. National Association of REALTORS Research Group. https://www.nar.realtor/sites/default/files/documents/2021-home-buyers-and-sellers-generational-trends-03-16-2021.pdf. Published March 16, 2021. Accessed December 30, 2021.
[7] Fontinelle A. 5 Types of Private Mortgage Insurance (PMI). Investopedia. https://www.investopedia.com/mortgage/insurance/. Published June 10, 2021. Accessed December 30, 2021.
[8] Martin EJ. Physician mortgage loans: Pros and cons for doctors buying a home. Bankrate. https://www.bankrate.com/mortgages/physician-mortgage-loans/. Published June 2, 2021. Accessed December 30, 2021.
[9] Richardson S. Physician Loans: Are They A Good Mortgage Option For Doctors? Rocket Mortgage. https://www.rocketmortgage.com/learn/physician-loans. Published February 4, 2022. Accessed February 9, 2022.
[10] 10 Reasons Why Residents Shouldn’t Buy A House. The White Coat Investor. https://www.whitecoatinvestor.com/10-reasons-why-residents-shouldnt-buy-a-house/. Published June 23, 2020. Accessed December 30, 2021.
[11] Ponder C. How Much Does It Cost to Refinance a Mortgage? Lendingtree. https://www.lendingtree.com/home/refinance/how-much-does-it-cost-to-refinance/. Published March 31, 2020. Accessed December 30, 2021.
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- Buying a house during residency: The physician mortgage loan - February 15, 2022
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