For a new doctor eager to buy a home but carrying the weight of student debt, a physician mortgage can be a springboard for entering the housing market.
With such a mortgage, also known as a doctor loan, the underwriting process is more lenient compared with a conventional loan. But consider the pros and cons before signing on the dotted line to make sure this option is right for you.
“The main advantages of doctor loans are access to financing with little to no money down and no required private mortgage insurance,” says Bryan Richardson, SunTrust Bank’s portfolio product manager, based in Richmond, Va. “This results in a lower payment when compared to products that do require mortgage insurance.”
Conventional loans require private mortgage insurance, or PMI, when a borrower makes a down payment of less than 20 percent or refinances a mortgage with less than 20 percent equity in the house. PMI fees vary—depending on your credit score, mortgage product and term, and the size of your down payment as a percentage of the value of the home (LTV)—from around 0.3 percent to about 1.5 percent of the original loan amount per year, according to Bankrate, a personal finance website. On a $200,000 loan, this translates to a payment of $2,000 a year, or $167 per month, assuming a 1% PMI fee.
The flip side of a no-money-down option, Richardson warns, is you will have little to no equity. If property values decline, you could find yourself underwater, meaning you owe more on the mortgage than the home’s fair market value.
That is a common concern for any affordable mortgage program featuring a zero or no-money-down option, including government-sponsored loan products. A physician mortgage will also generally have a slightly higher interest rate than a conventional loan. That, when combined with financing the full purchase price of a house, can mean significantly more interest paid over the life of a loan.
Crunching the numbers
This example shows how the numbers break down on the purchase of a $300,000 house:
With a doctor mortgage, you pay $0 down with a $300,000 balance on a 30-year fixed rate loan at an estimated 4.5%. Your monthly mortgage payment is $1,520.06. Over the life of the loan, you will pay $247,220 in interest.
With a conventional 30-year fixed rate loan with 20 percent down ($60,000, in this case), you finance the $240,000 balance at an estimated 4.25%. Your monthly mortgage payment is $1,180.66 and you’ll pay $185,036 in interest over the life of the loan. But if you pay down the same amount monthly as the physician mortgage ($1,520.06), you will pay off your mortgage in less than 19 years instead of 30. Over the life of the loan, you will pay $112,243 in interest, a savings of nearly $135,000 in interest over the doctor loan option.
Liberal risk assessment
A bank that handles physician loans is more likely to keep and service them rather than sell them to other financial institutions, according to Mandi Moynihan, a certified financial planner with Pauley Financial in Austin, Texas.
“This allows the lenders to make more judgment calls in the underwriting and approval process,” she says. “They can do the risk assessment and often take a more liberal approach with physicians.”
Physician mortgage lenders take into account a doctor’s potential future income when weighing the risks of student loan debt and scant savings. Lenders will often accept an employment contract and a copy of the doctor’s medical license as proof of income. Additional documentation might be required for self-employed doctors.
“Not many professions have such a rapid increase in income,” says Moynihan. “As your income increases, the big challenge is to not increase your lifestyle to keep up with the income.”
SunTrust includes student debt in the credit decision unless the borrower can document that the student debt is deferred or in forbearance and will be in forbearance for at least 12 months after closing the mortgage transaction.
Doctor loans are not a one-size-fits-all option. Consider your individual situation to decide whether one is right for you.
At SunTrust, for example, Richardson says a loan originator will look at how long borrowers intend to stay at their current jobs.
“We want to make sure we’re recommending the mortgage program that best fits clients’ needs,” he says. “That’s one of many things the loan officer will be discussing with the client.”
Even if you qualify for a zero-percent down loan, a prudent approach would be to make a modest down payment to lower your monthly mortgage payment and decrease your risk of loan default.
Since selling a home costs money, buyers who finance the full purchase price are automatically underwater. Seller costs can include: real estate agent commissions (typically 5-6% of the home price), other closing costs or credits to the buyer, transfer tax, capital gains tax, a home warranty for the buyer and moving costs.
As with any mortgage, you will be required to pay closing costs for a physician mortgage. All funds that are put towards the transaction will need to be verified, including closing costs.
If you already have accumulated a large amount of debt, consider the risks of adding to it with a zero-percent down payment loan.
“Ultimately, why these loans can fail is they are expensive,” says Moynihan. “You get in over your head with a larger mortgage payment if you buy more house than you need.”