Are Physician Mortgage Loans a Good Idea?
By T.J. Porter, WCI Contributor
The White Coat Investor
Buying a home is a major investment, and few people can afford to pay cash for such an expensive asset. Instead, most people—even high-earners like doctors—borrow money to buy a home. Qualifying for a typical mortgage requires good credit, low debt, and proof of income—something that not all young doctors have, especially those who are straight out of residency or medical school. To help doctors purchase a home, though, some lenders offer specially-designed physician mortgage loans.
Here's more information on physician mortgage loans and whether they're a good idea for doctors looking to buy a house.
What Is a Physician Loan?
A physician loan is a specially-designed loan that meets the unique needs of doctors. Doctors usually earn high incomes or, if they're in medical school or residency, can reasonably expect to get a high-paying position in the near future. However, young doctors just starting out in their careers might find themselves with little savings, huge amounts of student loan debt with correspondingly low credit scores, and no immediate source of income.
This means that young doctors are often the exact opposite of the type of person that lenders look for when it comes to getting a conventional mortgage. To qualify for a more conventional loan, you usually need strong credit, low debt, and a provable source of income that is sufficient to pay your bills.
The reality is that, even if doctors don’t look like great borrowers on paper due to poor credit and high debt, their high earning potential makes them a good bet for lenders. That's where a physician loan could come in handy.
How Do Physician Loans Work?
Physician loans work by taking the unique circumstances of doctors into account when it comes time to make a lending decision. Lenders who offer doctor loans typically focus more on monthly debt payments compared to income rather than overall levels of debt. They also allow signed employment contracts to serve as proof of income, even if a white coat is not working and earning money yet.
Another perk is that physician loans don’t require the 20% down payment that conventional mortgages do. Even if you don’t make a 20% down payment, you won’t have to pay Private Mortgage Insurance (PMI). That means that doctors can more easily qualify for these loans when they get out of medical school or residency.
Each lender can design its own physician loans and set terms and conditions, so you should take some time to compare offers from multiple lenders.
Once you get the loan, it works just like any other mortgage. You get a bill each month and submit a payment. Over time, you pay down your balance and eventually pay off the loan.
Do Doctors Get Better Loans?
Whether doctors get better loans will depend on your financial situation and needs.
The main reason physician loans exist is to provide doctors with more flexible underwriting requirements. They’re better than conventional mortgages in the sense that they are easier for doctors to qualify for. In many cases, a young doctor who could never qualify for a normal mortgage can easily qualify for a doctor mortgage.
On the other hand, physician loans pose slightly more risk to lenders because they’re relying more on your future earning potential than on your proven track record of paying your debts. That means that many lenders increase the interest rate of physician mortgages by a small amount when compared to a conventional loan.
Even a small increase in interest rate can have a big impact on a mortgage’s cost. For example, a 30-year $400,000 loan at 3% APR would cost $1,686 per month or $606,960 overall. Add only 0.25% to that rate and the cost becomes $1,741 per month or $626,760 overall, an increase of about $20,000.
Do Physician Loans Have PMI?
One thing that can offset the higher interest rate on physician loans is the fact that you won’t have to pay for Private Mortgage Insurance (PMI), which is insurance that you pay for to protect the lender against you defaulting on the loan.
With conventional mortgages, lenders typically add PMI to loans where the borrower makes a down payment of less than 20%. In some cases, borrowers can avoid PMI with a 10% down payment through a process called an 80/10/10 loan.
Still, PMI can be a significant cost—even though it does nothing for you and is simply an expense that you pay to keep the lender safe. According to a study from the Urban Institute, PMI can run between 0.58% and 1.86% of the loan’s original value. Freddie Mac, a governmental mortgage enterprise, estimates PMI at $30-$70 per month for every $100,000 borrowed.
Some physician loans will let you put down 5% or even nothing when you buy a home with no PMI requirement. That savings can offset the slightly higher interest rate the loans carry.
Benefits of Physician Loans
Some of the benefits of physician loans include:
No PMI. You can avoid the additional cost of Private Mortgage Insurance without having to make a 20% down payment.
Minimal down payment requirements. Some physician loans will let you buy a home with no down payment at all. The lowest down payment available to most people is 3.5%, which comes through the FHA Loan program and involves a number of restrictions.
Easier underwriting. Physician loans are easier to qualify for than conventional mortgages, especially if you have high amounts of debt or haven’t started working yet. Underwriters pay more attention to your monthly loan payments and your ability to make those payments based on your future income.
Higher loan limits. Many lenders will let physicians borrow as much as $2 million with a physician loan—an amount that can be difficult to get through conventional lending.
Disadvantages of Physician Loans
There are some drawbacks to consider before applying for a physician loan.
The temptation to buy more house than you should. When a lender looks at your application and offers to give you a loan for $1 million or more, it can be very easy to wind up spending more than you planned to on a home. The high loan limits on physician loans make it very easy to buy too much house and wind up house-poor.
Lack of savings is dangerous for homeowners. A benefit of physician loans is that you don’t need significant savings to qualify. However, that is a double-edged sword. If you have no savings and wind up needing to replace an appliance or make significant repairs to the home you just bought, you’ll have to come up with the money somehow. That can mean applying for a new loan to cover those costs or dealing with a poorly-maintained home until you can build up your savings.
Buying and selling expenses. Real estate transactions can be expensive. You can expect to pay a few percent of a home’s value in fees when you buy or sell. Ultimately, that means that it can take years of living in a home before you can sell it and turn a profit, or even break even on the deal. If you’re in medical school or a young doctor in residency, there’s a good chance you won’t stay in the same place for the long term, so you may wind up saving money overall by renting.
Is a Physician Loan for You?
If you’ve decided that it’s the right time for you to buy a home, you’ll have to think about whether a physician loan or a conventional mortgage is right for you.
Ultimately, physician loans have a lot of benefits, but those benefits are centered around the underwriting and approval process. They’re easier to qualify for but that comes at the cost of slightly higher interest rates.
If you have the savings to make a sufficient down payment to avoid PMI and you can qualify for conventional financing, you’ll likely save money in the long run by getting a conventional mortgage.
If you can’t qualify for a conventional loan and feel strongly that buying a home is the right move, then a physician loan is a good choice because it will let you buy a home when you otherwise couldn’t.
If you simply have a better use for limited funds, you may also choose to get a physician mortgage so you can max out retirement accounts or pay off student loans with that money instead.
