2017 Guide to Doctor Mortgage Loans & Buying a First Time Home
Most physicians dream of buying a beautiful home in a safe neighborhood that will house their family for years to come. As first time homebuyers, young doctors often make major mistakes in the home purchase process.
New physicians find themselves in a unique financial situation when they apply for their first mortgage. On the one hand, they have substantial earnings potential. On the other hand, they have little income history, a massive amount of student loan debt, and little to no savings. So how do they buy that perfect home
New physicians, as first time home buyers, face a major financial decision that impacts their ability to reach other financial goals like paying off student loans, saving for college and investing for retirement.
With a new income, a heavy student loan burden and little or no savings, young doctors may have difficulty when applying for a first mortgage.
When Should Physicians Buy Their First Home?
Young doctors, even interns and residents, may be tempted to buy their first home as early as possible. For many new physicians, this leads to one of the greatest financial mistakes they will make. Typically, young doctors have very little money to use as a down payment so they have little or no equity in the home they will buy. This presents no problem when the real estate market and home prices are moving upward, since that means they are making money on the home. However, when home prices decline, all of the equity in the physician’s home may be wiped out, and they may even find themselves with negative equity, known as being “upside down” on the mortgage. If they are forced to sell. a physician family would actually need to bring cash to the closing, effectively having to “write a check” to sell their home.
Generally, physicians are well-advised to buy a home when they are certain they will be in the same city for at least seven years. Often, this means waiting to buy a home until after they have finished residency, finished fellowship and even after making partner with a new practice.
Physician families who are expecting a new baby often rush to buy a home near a good school in hopes that their child will attend there. However, schools change over time and children often have needs that are unexpected, so it may be a better idea to purchase a first home when the first child is nearly ready to enter kindergarten.
While young doctors may find this to be a very long wait, it gives plenty of time to build an emergency fund, pay off debts with higher interest rates and save a larger down payment. Many argue that renting is not a good idea but most fail to remember that the first several years worth of mortgage payments are composed primarily of interest, so little goes toward the loan’s principal.
How Much House Can a Young Doctor Afford?
Young doctors often qualify to buy far more home than they really should. Mortgage lenders consider only a physician’s ability to meet their loan obligations when they do underwriting, so the home loan amount physicians qualify for may be a number that will get them into trouble.
While it is tempting to use a rule of thumb, such as a multiple of income, physician families who are intent on achieving financial security should factor in all of their other goals before they decide how much home to buy.
The home buying decision is one place where the financial planning process is particularly effective for young doctors:
Set financial goals other than housing by thinking about the timing and cost of retirement, college, paying off student loan debt, private school, travel and major purchases.
Calculate the savings needed for all non-housing financial goals and express these as monthly expenses.
Determine costs of living not related to costs of housing.
Determine how the amount of home mortgage payments by starting with the physician family’s gross pre-tax income then deduct amounts for pre-tax retirement savings, income taxes, non-housing debt payments and other non-housing costs of living. The resulting number will be the monthly discretionary income available to pay housing-related costs including principal, interest, property taxes and homeowner’s insurance.
Using the figure calculated above as well as figures related to current mortgage interest rates, determine how much housing debt the physician can assume and service.
Using the mortgage figure, calculate the down payment and arrive at the purchase price for the physician’s first home.
While this process may seem laborious, it will lead physicians to a precise answer to the question, “How much house can I really afford?” and it will put the home purchase decision in its proper context: as one major goal among many important financial goals that lead to financial security.
How Should a New Physician Finance a First Time Home Purchase?
Young medical professionals have several options when it comes to getting a first mortgage, and at least one option—the “doctor loan”—is intended only for them.
Conventional mortgages are for borrowers with an excellent credit score, low debt-to-income ratio and 20% to apply to a down payment. Since the limit on conforming loans is $417,000, the optimal home purchase price for a doctor using conventional financing will be $512,250 (which is a $417,000 loan plus a $104,250 down payment that is 20% of the home price). This financing option is a good fit for young doctors who live in areas with a lower cost of living, those who have received substantial gifts from family, those who have saved diligently and those who want to live in lower-priced homes.
FHA Loans are a good fit for physicians who have less than 20% for a down payment and those who need to borrow more than the conforming limit. FHA loans require the payment of principal mortgage insurance (PMI) of 1.75% of the loan amount up front, plus about 0.5% of the loan amount until the loan to value ratio drops to 80%. It may be possible for physician borrowers to accept a loan with a higher interest rate that factors in the PMI so that the PMI is effectively tax-deductible.
VA Loans are a good fit for military doctors and physicians who served in the military as part of their training. The main benefit of a loan backed by the Veterans Administration is that no down payment is required, so 100% financing is available. Certain limits apply on a county-by-county basis.
“Doctor loan” is a mortgage for physicians in their first ten years of practice, including residents and fellows. While each bank has its own doctor mortgage program, the thing most doctor loans have in common is a low or zero down payment and no principal mortgage insurance (PMI). Some physician home mortgage lenders may charge higher rates for their loans but most will allow borrowers to have larger loan balances than the conforming limits and will accept a written contract as documentation during the underwriting process.
We hope that our Guide for Physicians Buying a First Time Home can help you make sense of the personal finance issues that affect doctors while helping you avoid mistakes and seize opportunities as you and your family plan for financial security that can last a lifetime.