A few years ago, Bank of America realized that there was an untapped potential market out there for mortgage business. Every year 16,000 new doctors graduate from medical school and about the same number graduate from residency. These people have little money, are financially naive, have vast sums of future earnings potential, and, best of all, almost all of them will soon purchase a mortgage. Yet, by standard criteria, they will have a difficult time securing a mortgage. They don’t have anything to put down,
they have a ton of debt already, and no proven earnings. They usually haven’t even started their job yet when they buy a home in a new city. Why not create a program that allows these high future-earners to buy a mortgage from the bank? The chances of them defaulting is very low (0.2%-much lower than a standard borrower) and they’ll soon need someplace to do their banking and investing too. We can use a relatively high interest rate and fees, since they’re not all that financially sophisticated and since they don’t have many other options anyway. If they’re like most doctors, they’ll go on recommending us to all their colleagues in the future. Thus, we see the creation of “the doctor loan.”
What is a doctor’s loan?
A doctor’s loan:
- Is made to a new resident, new attending (7-10 years out of residency or less), or dentist only (although some offer loans to veterinarians, optometrists, podiatrists, and even attorneys)
- Requires little money down (0-5%)
- Doesn’t require the borrower to purchase mortgage insurance (PMI)
- Will accept a contract as evidence of future earnings (instead of paystubs the doctor doesn’t yet have)
- Requires the physician to open a bank account at the bank from which the mortgage is paid by auto-draft
- Is designed for townhomes, rowhouses, and single family homes (not condos)
- Has the same rate whether loan amount is above or below “jumbo loan” limit ($417,000 in my area)
- Some programs even allow you to use gift money for a down payment
- Requires cash reserves equivalent to a few months of Principle, Interest, Taxes, and Insurance (PITI), a reasonably good credit score, and a loan payment to income ratio of no more than 38%
- Often doesn’t calculate student loans toward the loan to income ratio
What other options does a doctor have?
- Conventional 20% down mortgage- Often the best choice for a mortgage as it offers the most options (30 year fixed, 15 year fixed, ARMS etc), the lowest fees, and the lowest rates. It does require proof of earnings and a substantial sum of money to put down. That money, of course, becomes unavailable to invest elsewhere.
- 80/20 and 80/10/10 loans- These have essentially disappeared from the scene since the real estate meltdown. The theory was that you would get an 80% loan at a slightly higher rate than on a 20% down loan, then get a 20% loan at a much higher rate. You would avoid PMI (which isn’t tax-deductible) replacing it instead with more interest. The 80/10/10 and 80/15/5 were variations on the theme, with a downpayment required.
- Conventional mortgage with less than 20% down- These loans have higher rates and fees than a 20% down mortgage. They also require you to purchase PMI. It is rare for you to find one that is 0% down, but 5% and 10% down are common.
- FHA Loan- This loan has higher rates and fees than a 20% down loan (notably a 1% “funding” fee), a 3.5% required downpayment, and requires mortgage insurance. The rates are generally, however, slightly lower than a doctor loan.
- VA Loan- This loan requires that you qualify for VA benefits, which disqualifies many. It is an improvement on the FHA loan in that the 3% downpayment is not required and there is no mortgage insurance requirement. Rates are similar to FHA rates, but the funding fee is higher- 2.15%.
Who can I get a doctor’s loan from?
Compass Bank, Suntrust Bank, Regions Bank, Bank of America, Huntington National Bank, Fifth Third Bank, Utah Physician Home Loans, and a mortgage broker called Tower Mortgage all provide physician loans. I am confident there are others out there as well. Each of these only offers loans in certain states, so there might only be one or two (or even none) of these options available to you. Unfortunately, I have been unable to find a comprehensive list of which lenders are available in which states. It is also difficult for me to recommend one lender over another, as most doctors only buy one of these in their lifetime, and all those who work in the industry are obviously biased. But the selection process is made much easier by the fact that only a few lenders will likely be available in your state. (Lenders, if you would like to submit information about your particular loan and states you offer it in, contact me)
If you’ve decided to go ahead and get one of these loans, this section ought to help you narrow down the choices.
Utah Physician Home Loans: UT, AZ, NV, ID, OR and CA (via Arizona Physician Home Loans, Nevada Physician Home Loans, Idaho Physician Home Loans, Oregon Physician Home Loans, and California Physician Home Loans)
Fifth Third Bank:WI, MO, IL, IN, OH, KY, MI, TN, AL, GA, FL, NC, SC, VA, WV, PA
Compass Bank: AL, TX, NM, CO, AZ, CA and parts of FL. Other states possible if you’ve been a Compass customer for at least 6 months, including AR, CT, GA, ID, KS, LA, MA, NV, OH, OK, OR, PA, TN, VA, WA and some parts of NY
Regions Bank: TX, IA, MO, AR, LA, IL, IN, KY, TN, MS, AL, GA, FL, VA, NC, SC
Washington Trust: MA, CT, RI, and NH.
How do rates and fees compare?
The doctor’s loan rate generally has the highest rate of all these options. But the down payment is the smallest. The fees are where things get really blurry and hard to compare. On the one hand, the FHA and a conventional loan with less than 20% down require mortgage insurance, which unlike loan interest, is not tax-deductible for those with incomes over the phaseout range of $100-109K. It is often hard to tell if you’re better off paying mortgage insurance or a higher rate/fees. It is much easier to get rid of origination/funding fees by putting 20% down, most other loans, including the doctor’s loan, will hit you with these fees. (Although at least one doctor’s loan will waive this is you’re willing to pay a higher interest rate.) The fees at Regions Bank are currently $675 plus 1% of the amount of the loan. The doctor’s loan rate is currently about 1/4% higher than a comparable FHA/VA loan. But if you compare the rates and fees to a conventional 20% down loan, you’re in for some sticker-shock. The Amerisave rate (which I found to be about the going rate while mortgage shopping recently) for a no-fee, no-points, non-jumbo 30 year fixed loan today is 4.5%. A similar doctor’s loan is offered at 5.375%. That might not seem like much, but over 30 years on a $500,000 home, that is a lot of money. With the doctor’s loan, you’ll pay $508,000 in interest. If you put 20% down, you’ll only pay $330,000 in interest because it is a smaller loan and a better rate. Plus, you don’t have to pay the extra $5,675 in fees up front. That money compounded over 30 years at 8% is another $57,000. So the benefit of using a regular old 30 year fixed loan with 20% down could be as much as $235,000 on a $500,000 home. This, of course, ignores the opportunity cost of that $100,000 down payment, which we’ll discuss below.
Should I get a doctor’s loan?
There is a lot that goes into this question. It is my opinion that most residents and fellows should rent instead of buy for several reasons. First, you’ll probably only be in that location for 1-5 years. It usually takes at least 5 years to break even on a home, obviously more if a real estate bubble bursts on you. The best resource to see how long it will take to break even in your particular circumstances is the New York Times Buy vs Rent Calculator. Even if you decide to stay in the same area as an attending, I’ve found that attendings don’t usually like to live in their “resident home” once their income quadruples. Second, a resident/fellow doesn’t make very much money and so usually takes the standard deduction on their taxes. That means your mortgage interest is NOT deductible. Even if you itemize, most of your interest probably isn’t going to be deductible. That increases the effective cost of your shelter. Third, homes require maintenance (expect 1% a year), which requires time and money, neither of which are abundant to a resident. Fourth, there is a lot of hassle and expense involved with buying and selling a home. Renting a home is quick and easy by comparison. If you’ve ever tried to sell a home in a down market you know how tough it can be to sell it at any price, much less a reasonable one. Plus, there is a great deal of flexibility with renting. If you don’t like the neighborhood, you just move. At worst, you’re in for a one year contract. No big deal. New attendings, on the other hand, are much more likely to stay put and the interest is much more likely to be fully or nearly-fully deductible. The buy/rent ratio sways heavily toward buying for most.
If you’ve decided to buy a home, you should give serious consideration to putting 20% down and getting a conventional mortgage. The improved monthly cash flow will allow you a great deal of financial freedom and ability to invest (and even spend.) You’ll save hundreds of thousands on interest over the life of the loan, all guaranteed, unlike investing a potential down payment elsewhere. But if, for whatever reason, you’re going to buy a home AND you can’t or don’t want to put 20% down, then a doctor’s loan is a reasonable option and at least as good as the other non-20%-down options.
Isn’t it better to get as big a loan as possible and invest the difference?
When you run the numbers, you can easily see you’ll be better off borrowing as much money as possible and investing it at a higher interest rate. This is the benefit of leverage. Consider the $500K home discussed above. You save $235,000 using a 20% down conventional loan over the doctor’s loan. But if you invested that $100K downpayment at 8% over 30 years, you’d end up with over $1 Million. The terms of this “margin investing” are favorable, in that you have a lot of time for the market to rebound and there are no margin calls. Unfortunately, there are a few reasons why you probably don’t want to do this:
1) Getting a lower interest rate on the mortgage is risk-free. That $235,000 is guaranteed. The $1 Million is not guaranteed. If there is anything the stock market has taught us over the last decade, it is that there are no guarantees. Risk of loss is very real. If you get 2% returns over the 30 years instead of 8%, you’d have been far better off with the lower rate mortgage.
2) Being underwater on a mortgage is no fun. Putting 0% down means you are immediately underwater since it generally costs 6-10% of the value of the home to sell it. If you think it is hard to sell a home in a down market, try doing it when your only options are a short sale, coming up with tens of thousands in cash, and letting the bank foreclose and ruining your credit.
3) Behavior. It is much easier to spend money than to invest it. To come out ahead you have to actually invest and keep investing that $100K for 30 years. Taxes and investment expenses, of course, can also reduce the rate of return on that money if you have poor investor behavior.
4) Cash flow and investing the difference. Putting 20% down lowers your mortgage payment dramatically. Again taking that $500,000 home example. With 20% down, your monthly principle and interest payment is $2027. With the doctor’s loan, it is $2800. That $800 a month can really make a difference in your budgeting-giving you more spending and savings options as they become available. You can even use that $800 a month to pay down the mortgage by getting a 15 year fixed mortgage instead. That would lower your interest rate another 3/4%, saving you even more over the years and allowing for earlier retirement. Alternatively, you could just invest the $800 each month. At that same 8% rate of return, after 30 years you would have $1.2 Million, even more than the $1 Million that $100K down payment would grow to. So overall, if you invested the difference after 30 years of 8% annual returns, you’d come out over $400,000 ahead by putting 20% down. But, of course, you still have to come up with the 20% to put down, which isn’t easy.
Thanks to Chris Roberts at Regions Bank for his time in being interviewed for this post. (Disclosure- I do not make any money from Regions, Amerisave or any other bank if you contact them through a link here. However, if you would like to purchase advertising space or offer an affiliate program, contact me. )