On the surface, physician mortgage loans look great. No money down. No jumbo limits. No private mortgage insurance (PMI). But let’s be real. Lenders are in business to make money and they can’t just give you a free ride. So, how do these loans stack up against everything else that’s available? Are they really as good as they sound?
You’ve already made a solid decision about how much to spend on your home and you have your financial ducks in a row. Now, it’s time to decide how to finance your home and whether a physician mortgage loan is the best option for you.
To help you make an informed decision, we’ll cover:
- How Physician Mortgage Loans Work
- Alternatives and How They Compare
- Deciding On The Best Mortgage For Your Situation
Physician Mortgage Loans
Physicians are extremely profitable customers for lenders. They take out big loans early in their careers and almost always pay them off. Lenders use physician mortgage loans to lock in early-career physicians by lending them more money with fewer stipulations than their competitors. They make it even more appealing by marketing it as a “special program” just for physicians.
The goal is to get you in the door and sell you other stuff as your needs change. A medical student transitioning into residency with zero earnings history, no cash and a boatload of student loans would normally never qualify for a mortgage if it wasn’t for physician mortgage loans. However, there’s no such thing as a free lunch. These loans are appealing at first, but often end up being more expensive than the alternatives.
What’s So Special?
So how is the physician mortgage loan different than a typical mortgage? Here are some of its common features:
- Zero (or very low) down payment required
- No private mortgage insurance “PMI”
- No rate increases on jumbo loans (typically, loans larger than $417K)
- Lending based on a physician’s signed employment contract
- Less critical of student loan debt
Who Counts as a Qualified Borrower?
A “qualified borrower” is normally a medical resident, fellow or attending physician with a signed contract for employment. Some lenders also include dentists, veterinarians, and other doctors.
Who Offers Physician Mortgage Loans?
There’s a growing list of lenders offering physician mortgage loans, including:
- Fifth Third Bank
- Republic Bank
- Huntington Bank
- Bank of America
- Regions Bank
- Citizens Bank
- SunTrust Bank
- Bank of Nashville
- Physician Loans
(Note that we do not have a financial relationship with any of these lenders. If you’re a lender and would like to be added to our list, please let us know.)
There are a few costs that make up your total mortgage expenses:
- Interest – The cost of interest is based on the interest rate, loan balance and loan repayment term
- Closing costs – A one-time, out-of-pocket expense paid at closing, wrapped into the loan balance or wrapped into the loan in the form of a higher interest rate
- PMI – The monthly fee typically paid until reaching 20% equity
Closing costs and interest rates are kind of like a teeter totter: reducing closing costs on a mortgage increases the interest rate. Or if you want the lowest rate possible, you’ll have higher closing costs. You can see how this works in this breakdown from the Mortgage Professor website.
As for PMI, you either have it or you don’t. It’s typically going to cost between 0.3% to 1.5% of the original loan amount per year. A surefire way to avoid PMI is to put 20% down. Some loans, however, like the physician mortgage loan, do allow you to avoid PMI even though you don’t have 20% equity.
Another way to avoid PMI is to get two mortgages – one that finances 80% of the deal and the second that covers the remaining debt (up to 20%). But keep in mind that all of these PMI avoidance tactics come with additional costs.
Rates and Costs
Let’s assume you’re a physician considering a $500,000 home. You have fantastic credit but no cash for a down payment. What are your options for mortgages with no PMI? Here are the most popular:
- Physician Mortgage Loans: 30 yr fixed rate – 4%
- Physician Mortgage Loans: 7/1 ARM – 3.25%
- Conventional 80/20:
– First mortgage (80%) – 30 yr fixed – 3.5%
– Second mortgage (20%) – Interest only HELOC (prime + .5% or 4% today)
- VA Mortgage (must be military): 30 yr fixed rate – 3.25%
Which Option Should You Choose?
If you’re in the military, the VA Mortgage is usually a home run, especially if you’re considered disabled.
Physician mortgage loans have the highest interest rate but it’s locked in. The ARM has a better rate than the 30-year physician mortgage, but the rate becomes variable after seven years.
The conventional 80/20 offers the best rate on the primary mortgage, but the second one has a variable rate.
Assuming you’re not in the military and can’t get a VA Mortgage, you should base this decision on how long you’ll own the home and how much you plan to pay on the mortgage. Let’s go over the best options based on these factors:
- 0-7 years – If you don’t foresee yourself living in the home for at least seven years, the Physician Mortgage Loan 7/1 ARM is your best option. But, really, if you plan on living in it for fewer than five years, you should be renting.
- 7+ Years (and average income and savings) – In this case, the Physician Mortgage Loan with 30-year fixed rate is the better choice. But this should be revisited when you have 20% equity, you drop below the jumbo limits or if rates drop in general. Once you fit the profile, you can often refinance into a new, non-physician loan that’s much more competitive.
- 7+ Years (and ability to pay the HELOC off very quickly) – The Conventional 80/20 typically provides the best deal if you can get the home equity line of credit knocked out within a year or two.
To simplify the math, we didn’t include closing costs. We always suggest asking lenders to provide an estimate with as close to zero closing costs as possible – at least for starters. That way,compare apples to apples. It’s much easier to compare mortgages structured similarly from a cost standpoint.
Should You Put Cash Down?
What if you have some cash to put down or are considering waiting until you have the cash? In that case, you’ll be comparing the physician mortgage with the conventional 20% down mortgage. Once again, we’ll assume both are structured to wrap closing costs into the loan to make the math simpler. To give you a clear comparison, let’s structure the 20% down conventional loan to have the exact same payments as the physician mortgage loan. The only difference is the down payment and the interest rate.
Option #1 – $100K down payment conventional loan
- $400,000 balance
- 18.1183 year fixed rate at 3%
- $2,387.08 per month principal and interest
Option #2 – $0 down payment physician mortgage loan
- $500,000 balance
- 30 yr fixed rate at 4%
- $2,387.08 per month principal and interest
Looking at those numbers, you’re probably thinking you’d take the $0 down option. Maybe you don’t have that much cash available or maybe you think there are smarter ways to use that $100,000. You could use it to pay off loans or start investing. And 4% is still a really good rate. But how does it really compare to the 20%?
The total lifetime interest costs:
- Option 1 – $118,998
- Option 2 – $359,348
Coming up with the $100,000 will end up saving you over $240k in interest, plus you’ll get your mortgage paid off almost 12 years sooner. On top of that, having equity will provide greater security and flexibility, especially if something unexpected happens. With the 100% financed physician mortgage loan, you should expect to start out underwater. If something doesn’t work out and you’re forced to sell quickly, you should be prepared to write a potentially large check for up to 10% of the purchase price just to get out of the home.
On the flip side, if you do come up with the $100,000, you could finance 100% using the physician mortgage loan and invest the cash. If you run those numbers, the end result will look much better. But not only does this require an aggressive investment, it also requires greater leverage on your home, which further adds to the risk. It will also require many years of disciplined investing and assumes you never spend any of it. That’s not impossible, of course, but it’s much easier said than done.
At the end of the day, getting the conventional mortgage and paying it off more quickly is a much better deal. If you don’t have the cash for a down payment, however, the physician mortgage loan is a solid alternative worth considering. Still, it’s not always automatically best solution.
What if You Already Have a Physician Mortgage?
If you already have a physician mortgage loan but you’re not paying attention to it, there’s a good chance you’re throwing away good money. You should review your options for refinance if any of the following occur:
- Interest rates drop
- You reach 20% equity
- You get below the jumbo limits
- Your plans change
In the past few years there’s a good chance all four of these things have happened for many of you. Here’s a scenario that illustrates one of the most common money saving opportunities for physician mortgage loan borrowers:
Dr. Smith bought her home using a 100% financed physician mortgage loan at 4.75% in July of 2013. The original loan amount was $500,000 with monthly principal and interest payments of $2,608.24. The lifetime interest for that loan would have been $438,965.21. Fast forward three years to today and Dr. Smith’s property has appreciated to around $600,000 in value and she owes $475,712 on her original mortgage.
When she bought the home, she had no cash to put down and very few options. The physician mortgage loan was probably her best bet. But now that she has over 20% equity and a healthy earnings history, all sorts of options have opened up. Odds are she’d be able to qualify for the best deal around.
If she had the initiative to refinance and wanted to keep the payment similar to the one she was already used to, she’d be looking at a new 20-year fixed mortgage at 3%. The monthly principal and interest payment on the $475,712 new mortgage would come up to $2,638.29. More importantly, she’d be shaving seven years off her repayment term with only a $30/mo increase in payment. Now that’s a home run!
She could also consider refinancing into a new physician mortgage loan. That would have been better, but nowhere near as appealing as the conventional mortgage. She’s now in the sweet spot for traditional mortgages and she should take advantage of it.
When you’re considering a refinance, be sure to check out a few different lenders. And remember that while refinancing into a new physician loan may be a good deal, it’s not always the best one. Doing your homework before refinancing your physician mortgage loan will pay off. Ideally, you also have someone, like a financial planner, who can help you analyze your options objectively.
When Should You Avoid Physician Mortgage Loans?
You should probably stay away from physician mortgage loans if any or all of these conditions apply:
- The ease of getting a physician mortgage loan is causing you to consider buying too much house
- You have (or will have) at least 20% to put down on the home
- You’re in the military – look at a VA loan instead
- You expect a large influx of cash shortly after buying, and are using the physician mortgage to get the deal done now
- You aren’t comfortable with the prospect of starting out 5-10% underwater on your home (in other words, you don’t want to write a big check to get out of it if your circumstances change)
Alternatives to Consider Before Signing
In my opinion, it’s best to wait until you have at least 20% to put down on the home. That way, you’ll to get the best deal possible. Plus, you don’t have to take on any of the risks that come with financing anything 100%.
If you like that idea, go ahead and rent for now and start stashing away some cash in preparation for buying your first home. If you already own a home and plan to upgrade, the best way to save for your future down payment is by paying your current mortgage off more quickly. You might even consider refinancing your current mortgage into a shorter term to get used to monthly payments. You can also structure the new loan so that it allows you to build equity to the amount necessary to have 20% by the time you plan to upgrade.
There are several other types of loans we didn’t cover that could come into play. Here are some of them:
1) The Conventional Loan with PMI typically requires at least 10% down. If you have 10% to put down, this may be a better option than the physician mortgage loan, if you plan to own the home long enough for the PMI to stop.
2) The FHA Loan typically requires 3% down and has very competitive rates, but it also comes with a monthly permanent fee similar to a PMI. The monthly FHA fee makes it way less appealing for most borrowers.
3) The Jumbo Loan with PMI typically requires at least 10% down. This type of loan would be worth comparing to larger physician mortgage loans. Often, it comes down to how long you plan to own the home. The Jumbo might have a lower rate but it also comes with PMI.
Other Mortgage Resources
If you’re feeling overwhelmed by all of these options, please reach out to us. We help clients navigate these types of decisions all the time. We’re happy to set up a free consultation to find out whether we’re a good fit.
Or if you’d prefer to do it yourself, there are tons of online resources to help you learn more about mortgages. One of my favorites is the Mortgage Professor. This site has a great inventory of mortgage calculators and spreadsheets to help analyze mortgage options. You can also check mortgage rates based on your circumstances and without providing personal information.
Also, White Coat Investor has a great post similar to this one. It includes a very thorough list of physician mortgage lenders, including the states they work in.
Do you have any experience – good or bad – with physician mortgage loans? Share your story with us in the comments.
Have questions or care to share your experience? Ask/share in the comments!
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