Physician mortgage loans are physician home loans, or mortgage products, aimed at medical professionals who want to own a home before their income potential is fully realized – here’s everything you need to know about going that route.
When training to be a physician, it can feel like you’re stuck in a state of arrested development. In your early 20s, everyone else is starting a career while you’re still going to school. In your mid-20s, everyone is getting married and starting a family while you’re a busy resident with no social life. By the time you begin your career in earnest during your late 20s or early 30s, everyone else seems to be settled down. But while some of that is unavoidable, there’s no reason why physicians have to stand on the sidelines while everyone else buys a home.
What are Physician Mortgage Loans?
Physician mortgage loans are a special mortgage product available to doctors. Doctor home loans have fewer restrictions for borrowers than conventional loans because lenders generally trust doctors to be responsible borrowers. Doctors often apply for these mortgages when they’re in residency or shortly after graduating med school. Lenders will accept an offer letter as proof of income, which is an extremely rare scenario. Most banks want to see a stable history with a current employer. In fact, some will let you take out a mortgage months before your residency officially starts.
Doug Crouse, an expert in physician mortgage loans, states that lenders who offer physician mortgage loans accept 0% down, which is a rarity in the mortgage world. Most mortgage products with 0% down come with huge fees or specific requirements. This means borrowers don’t have to save thousands of dollars before they’re ready to buy a home. Most conventional loans require a down payment of at least 3-5%.
Physician mortgage loans also don’t charge private mortgage insurance (PMI) when a borrower puts down less than 20%. Almost every other kind of mortgage lender requires PMI when the borrower has less than 20% equity in the home.
Lenders who provide physician home loans often extend the same interest rates to jumbo loans, which are loans that are more than the Federal Housing Finance Agency conforming limit. In 2018, the jumbo loan limit is $453,100.
Doug states that one of the biggest reasons why doctors love physician mortgage loans is that banks don’t count student loans as part of the debt-to-income ratio (DTI), which they use to decide if an applicant is creditworthy. Typically, lenders want to see a DTI percentage of 43% or less. Since most doctors have student loans that are well over six figures, their DTI would render them ineligible for homeownership. That’s not the case with doctor home loans. Other types of loans still count toward DTI, including auto loans, credit card debt and personal loans.
That’s the best reason for pursuing a physician mortgage loan, Doug says. Many banks wouldn’t be comfortable lending money to someone making $50,000 a year with $250,000 in debt, but a lender who deals in physician home loans can see past those figures. They know that a resident will eventually be making at least $150,000 and be able to comfortably afford their mortgage.
Physician mortgage loans aren’t just for physicians. Some lenders offer a professional loan rather than a physician loan that is extended to other professions and doctorate degrees and are not limited to just medical doctors.
How do I Qualify for a Physician Mortgage Loan?
Though lenders are more lenient with physicians, you still need a credit score of 700 or more to open a doctor mortgage loan. It pays to have good credit too – borrowers with the highest scores pay the least amount in interest. Typically, the best rates are given to those whose scores are 750 or more. For the best rates, you typically need to have a fico of 760 or above. This will also qualify you for the lowest rates on PMI for non-doctor loans.
You can find a free copy of your credit report from each credit bureau – Equifax, Experian and TransUnion – at AnnualCreditReport.com. Look for any red flags, like debts that have gone to collection or missed payments. If possible, try to remove any negative marks on your credit report. It’s important to clean up your credit before you apply for a mortgage so you can get the best interest rate and terms.
You can sometimes find your credit score for free through your bank or credit card company, or through a service like Credit Karma. Those scores won’t be the same as what the lender will see when they pull your credit score, but you’ll get a basic estimate. If your credit score is below 700, take some time to examine why that is. It might be better to wait until your score is higher to pursue a mortgage.
The DTI ratio is also important mentions Doug. Just because student loans don’t count toward your debt, that doesn’t mean other loans won’t. If you have a high credit card balance or a $35,000 outstanding car loan, you might have trouble getting a physician home loan if you’re still a resident making $45,000 a year. If your ratio is close to 43%, try to pay down some debt before applying for a mortgage. Debt utilization is a very important part of how your credit score is determined. Keeping credit cards below 30% of the available credit will help you achieve the higher scores, Doug explains.
If you’re a self-employed physician, the salary requirements are a little different. You’ll have to present two year’s worth of income and show either a consistent or increasing income. The lender will then average the two years to determine how much house you can afford. Self-employed doctors should still have a strong credit profile and low DTI percentage.
Why Do Lenders Offer Physician Mortgage Loans?
Doctors fall into their own category. They don’t earn enough as residents to qualify for a large mortgage, with a very high DTI ratio and few cash reserves. In some cases, they’re the textbook definition of a bad prospective homebuyer.
However, they also have enormous salary potential, are responsible borrowers and some even get their student loans forgiven after 10 years of working for a public hospital or nonprofit. Doctors have an extremely low default rate on loans compared to the average consumer, which makes them very attractive to banks despite their initial financial shortcomings. Some figures state that doctors have a .2% default rate on loans while the average consumer has a 1.2% default rate. That’s why lenders offer physician mortgage loans to doctors, even while they’re still residents making $45,000 a year.
What are the Benefits of Physician Mortgage Loans?
The most obvious benefit of a doctor mortgage loan is that it doesn’t require a down payment. Almost all loans mandate some kind of down payment, between 3% and 5%. The only other kinds of mortgages that don’t ask for a down payment are VA loans available to military members and USDA loans for those buying homes in rural areas.
There’s more: with physician mortgage loans, borrowers will never have to pay private mortgage insurance (PMI). PMI is the fee that banks add to a mortgage when the borrower has put down less than 20%. Annual PMI costs are between .3% and 1.2% of the total mortgage. Avoiding PMI can save you hundreds or thousands each year, depending on the size of the mortgage. VA loans also don’t charge PMI.
There’s also no cap on how much borrowers can take out, and no higher interest rate for jumbo loans. Usually, mortgage companies charge extra for jumbo loans of $453,100 or more, but physician mortgage loans are exempt from that.
By not putting any down payment, borrowers can also save more money toward moving, furnishing their new pad or doing some minor home improvement projects. They can also use that cash as an emergency fund in case anything goes wrong with the house. As anyone who’s bought a home knows, it never hurts to have extra money in case something happens.
What are the Cons to Physician Mortgage Loans?
With all the benefits that come with physician mortgage loans, it’s hard to find an argument against them. There are fewer requirements to meet, and banks are eager to give out the money. Why would you turn down a physician mortgage loan in favor of a conventional mortgage?
Unfortunately, it’s not all sunshine and roses. Lenders don’t charge PMI on physician home loans and take on borrowers with a high debt-to-income ratio, so they make up their losses by charging higher interest rates. A recent rate comparison found that doctor home loans had an average interest rate of 5.375% while a conventional home loan had a rate closer to 4.5%. There can be a significant difference from one bank to the next. While most secondary market loans tend to be very similar from one bank to the next, doctor loans are a portfolio loan so each bank has their own set of rules and rates. While one bank might charge 3/4 to even 1% more than conventional others might not raise the rate at all so it is very important that you shop around to find the best deal.
That difference probably seems minimal, but it’s not. Let’s say you buy a $250,000 home with 0% down at 5.375% interest with a 30-year term. Unless you repay the loan ahead of schedule, you’ll pay $253,974 total in interest.
Another con to physician loans includes the fact that over half the lenders offering them do not offer them as fixed rates. This becomes a very important factor based on how long you plan to stay in the home. Rates are not likely to come down for many years to come giving you an opportunity to just refinance after the ARM fixed period is over like in years past. You can, of course, refinance at any point but don’t expect to lock in a rate as low as today’s fixed rates 5 or 7 years from now.
If you choose a conventional loan with 5% down at 4.5% interest, you’ll only pay $195,715 in interest after 30 years. The conventional loan will charge PMI, but even that won’t come close to making up the difference in interest. In the long run, the conventional loan will always be cheaper compared to the physician mortgage loan.
Of course, you can always refinance a physician mortgage loan to a conventional mortgage once you’ve built up some equity in the home.
Doctor home loans also tempt borrowers to put down as little as possible on their loans. In theory, it’s nice to offer doctors the chance to get a mortgage without saving for a down payment. In practice, this means new homeowners have no initial equity in the house. If they need to sell the home quickly, this could be a problem if the property value hasn’t increased enough to pay for the closing costs.
Some lenders also prohibit using a physician mortgage loan for a condo. If you really want to buy a condo, research lenders carefully to make sure that option is available. This is especially true of non-warrantable condos. Lenders make favorable loans to doctors because they are lower risk borrowers. Non-warrantable condos, however, are not low-risk properties and will be hard to get a doctor loan to purchase one. Expect to put at least 20% down on non-warrantable condos.
Alternatives to Physician Mortgage Loans
If you’re a doctor, you might not be aware that you qualify for other types of mortgages. Not sure if a doctor mortgage loan is your best option? Check out the other alternatives below.
FHA loans are backed by the Federal Housing Authority, which insures these loans to the lenders who provide them and are mostly targeted at borrowers with low credit scores. Conventional loans are only available to people with scores of 620 or above, but FHA loans only require a 580. If you put down at least 10%, you only need a 500 credit score. Most people think this is a first-time buyer loan which is not the case. You can buy a house using FHA even if you have already owned a home. The two biggest downsides to FHA loans are the upfront PMI of 1.75% and the monthly PMI is not only more expensive than conventional borrowers with good credit, but it must be paid for the life of the loan regardless of loan to value
Minimum down payments for FHA loans are also low, starting at 3.5%. This is the second lowest possible down payment available. Interest rates on FHA loans are higher than conventional loans because borrowers don’t have to be as qualified. FHA loans with less than 20% equity also come with mortgage insurance premiums (MIP), which is similar to PMI.
A conventional home loan is the most common kind of mortgage. It’s what most of your friends and neighbors probably have. A conventional loan has a few requirements for borrowers: They need to have a credit score of 620, a DTI ratio of 43% or less and a stable income history.
Consumers need to put down between 3-5% for a down payment, although it takes a 20% down payment to avoid PMI. Conventional loans aren’t backed by federal entities the way that VA or FHA loans are, which is why they have stricter guidelines. Lenders who provide conventional home loans charge higher interest rates for jumbo loans.
VA loans are only available to former or current members of the military, and they’re the best loan product available. Like a physician mortgage loan, a VA loan doesn’t require a down payment and also doesn’t charge PMI. Interest rates on VA loans are similar to conventional loans, so there’s no extra premium for choosing this kind of mortgage. If you’re eligible for one, a VA loan beats out a physician home loan almost every time.
Interest Options for Physician Mortgage Loans
A fixed-rate loan will have the same interest rate throughout the life of the loan, no matter how the market fluctuates. Since interest rates are still at historic lows, it’s a good idea to choose a fixed-rate loan to lock in the lowest possible interest rate.
Fixed-rate loans are available in 10, 15, 20 and 30-year terms, and rates are lowest for the 10 and 15-year mortgages. If you plan to stay in a home for a significant period of time, go with the fixed-interest rate. You’ll lock in a low rate and won’t have to worry about your mortgage payment changing from year to year. If interest rates go down in the future, you can always refinance to get the best possible current rate.
Adjustable-rate mortgages are just what they sound like: mortgages with interest rates that change over time. The most common adjustable-rate option for a physician mortgage loan is the 5/1 ARM. You can also find a 3/1 ARM, 7/1 ARM or 10/1 ARM.
ARMs are an interesting hybrid between fixed-rate and adjustable-rate loans. A 5/1 ARM has a fixed interest rate for the first five years and a variable rate for each year after. Interest rates are recalculated once a year, which means payments may be higher in subsequent years.
This kind of mortgage can be difficult to budget for since payments can change every year. The difference is usually minimal, but it can be dramatic depending on the market. The initial interest rate on the ARM is lower than it is for a fixed-rate loan, which is appealing to borrowers with great income potential. Most people say you should only get an ARM if you plan to stay in the home for five years or less.
How to Choose a Mortgage
If you’re struggling to decide between a physician home loan and a conventional loan, use this loan calculator to help you figure out the best option. Compare the total interest difference and decide if you’re comfortable with that variance. Look at your savings account and see if you can afford a down payment.
A financial planner can also review the options and help you figure out what makes the most sense. They’ll go over all the pros and cons so you can pick the mortgage that best fits your particular situation.
Why Physician Mortgage Loans Can be Dangerous
Banks love doctors – and they especially love making money off doctors. They know physicians are reliable borrowers, so they don’t mind lending them money. Unfortunately, this can lead to doctors borrowing more than they can really afford.
Before you sign up for a $500,000 mortgage, take the time to figure out how this loan will affect your budget. Will the monthly payment be affordable on top of your student loan payments? Will it let you make room for other priorities, like your child’s college fund or annual vacations abroad? What if you want to work part-time or teach instead of being a full-time doctor? Getting locked into a pricey mortgage can affect your future options, so consider those carefully.
Physician mortgage loans are also dangerous because they allow borrowers to take on a loan with no down payment. This means the consumer won’t have have any equity in the home for at least a few years. If the market tanks in their area, they could end up underwater on their home. In that case, it would be even harder to sell the home.
Are You Ready to Buy a House?
Buying a house when you’re a resident often sounds like a good idea. You’ve been in college for at least eight years, finally working as a doctor. Most of your non-med school friends have already been working for several years, and some are even married with a house and kids. As you push 30 and start feeling the urge to settle down, it seems like the perfect time.
But taking out a mortgage is a huge, huge commitment. Most experts agree that you shouldn’t buy a house unless you’re planning to spend at least five years or more in the home. When you buy a home, the mortgage is structured so that your initial payments mostly go to interest. It can take a decade before the majority of your payments will count toward the loan principal.
It’s not just the interest you pay at the beginning. When you buy a house, you have to pay for the appraisal, closing costs and moving expenses. If you plan to move as soon as you’re done with residency, you shouldn’t buy a home even if you qualify for one. Unless the area you’re in explodes in property value, you’ll probably lose money on the deal.
Buying a home is also a huge time commitment. Suddenly, you’re the one responsible for all the repairs and maintenance. If the water heater breaks at 5 a.m. on the one Saturday you’re not at the hospital, you have to deal with it. If there’s a flood in your area, you’ll be responsible for drying out your home if you don’t have flood insurance. When the AC breaks, you’ll have to figure out what kind of model you want to buy.
Being a homeowner also ties you down to the area. If you want to move after residency, you have to sell your home before you can afford to buy another one. Buying a house is like getting married – if it’s a good fit and you’re ready, it can be the best decision of your life. If you rush into the decision, it could be the most expensive mistake you’ll ever make.
How to Choose a Lender
If you’ve decided you want to buy a house with a doctor mortgage loan, it’s time to find a qualified lender. Finding a lender that offers physician mortgage loans can be tricky, as not all banks and credit unions offer them. If you currently have a checking or savings account, talk to that bank and see if they have a physician mortgage loan product you can apply for.
Before you start looking at open houses, contact a lender to start the pre-approval process. The pre-approval process is the first step to buying a home and is fairly straightforward. Lenders will just want to verify the basic information, like your income and your debts.
It’s OK to just get pre-approved with one lender before you’re ready to actually put an offer on a home. Once you find a home you like, it’s time to start searching for your final mortgage lender. You can either contact an individual bank, like one from the list above, or a mortgage broker, who has access to a wide array of lenders.
You want to get pre-approved first because you’ll find out about any potential issues before you put an offer on a home, like an error on your credit report. Getting pre-approved first also makes it more likely that you’ll get your offer accepted because it will show that you are a serious buyer.
When comparing mortgage lenders, you want to look for a few things:
- Closing costs: How much they charge to open and complete the loan
- Interest rate: How much interest you’ll pay
- Customer service: Lenders should be responsive and friendly
You want to get quotes from multiple lenders so you can find the best deal. Remember that the initial offer doesn’t have to be the final one, and always try to negotiate with the lender. You can always ask a lender to reduce the interest rate or closing costs.
Buying a home and choosing a physician mortgage is a huge decision – one that you should take some time to think about. Consider all the possibilities and make the decision that fits your life the best. Ignore what your friends or fellow physicians are pressuring you to do, like telling you to buy now because it’s a seller’s market. If you’re not clear on what the best route is, contact a financial planner who can help you see what makes the most sense.
Want to know more about physician mortgage loans? Step into the audio side and check out my interview with Doug Crouse!
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