It’s almost that time of the year again!
The snow is almost done falling. It’s melting into big puddles for our kids to stomp in. The birds and bees are coming back out. The trees are budding. Spring is upon us.
As many residents and fellows are inking their first contract, they are inevitably dreaming of their first home. Fleeting dreams of the white picket fence, birds chirping, and finally getting out of that crowded apartment dance like sugar plum fairies in many a physicians head.
Yet many physicians struggle with the reality of actually buying a home once they have finally transitioned to practice.
They’ve heard the horror stories of being turned down by the bank at the last second and don’t want to deal with the stress of this transition. They have enough other headaches to worry about!
Here are 3 tips to act as a preventive prescription to block this malady before you ever transition to practice.
Tip# 1: Beware of Costly Mortgage Insurance
One of the other things many loan officers miss for young doctors is the opportunity to avoid PMI (private mortgage insurance) or a mortgage insurance premium.
A physician can get slapped with an extra payment of PMI when they do not have 20% to put down to buy a home. The lender is required to get this insurance because the loan is labeled as “risky” without a whole lot of equity built into it at the beginning.
This tacks on an extra payment for insurance that will likely cost at least a few hundred dollars ever single month!
First of all, let’s be clear what PMI is. Conventional loans have PMI, private mortgage insurance. Government loans like FHA have a mortgage insurance premium, but they don’t call it PMI because it goes to the Federal government as insurance.
Essentially, if you’re putting less than 20 percent down, you have a form of mortgage insurance, whether you get a conventional loan or one backed by FHA. That insurance is a forced cost charged to you as the borrower, but insures the bank and/or the government.
Now, not only you get no benefit, but you can’t write it off on your taxes anymore!
In 2015, the new ruling from the IRS came down that mortgage insurance is no longer tax deductible. This extra payment of a few hundred dollars a month is really lost money.
With a physician loan, you can finance up to 100 percent, depending on what state you’re in and depending on what price range you’re in.
One way to avoid the extra cost of insurance is to pass on it and instead pay a slightly higher interest rate. Some lenders may do this to avoid the stigma of mortgage insurance.
In this scenario, you will find that interest rates are slightly higher- you’re going to pay an extra 0.25 percent to 0.90 percent higher in rate, but you’re saving compared to mortgage insurance which is 1.35 percent.
This means that you could save a full percent annually!
In addition, remember that the interest you pay on your mortgage IS tax deductible.
Consider that most physicians pay at least 30% in federal income taxes in their current bracket. In order to truly picture the difference, you have to deduct 30% from the rates. Even the extra 0.90 percent is truly closer to 0.60 percent when you factor in the tax deductibility. This is still half of the mortgage insurance costs.
Let’s say you save a whole percent a year on a $400,000 loan. That’s $4,000 a year over the first 10 years. That saves you $40,000!
Lastly consider that even if you are paying a little extra today, by two years from now, we bet that interest rates will be much higher than today.
You might be paying 0.25 percent more, but at least you’ve locked in a mortgage at an extremely low interest rate at 4.25 percent, 4.5 percent, or even 4.75 percent.
Whereas a year or two years from now, we could be looking at 5.5 percent, 6 percent mortgages again, depending on what happens with interest rates.
This way you’re able to leverage a higher loan-to-value and historically an incredibly low cost of credit.
Tip# 2: Get Enrolled in an Income-Based Repayment Program
Thinking of rates, the one rate that we see a lot of is 6.8 percent with the student loans that a lot of physicians have. Physicians, as they are in residency and out of residency, they’re facing choices like IBR, PER, or totally deferring their loans.
For example, when you go from med school to residency, there is a lot of change going on with those student loans. They’re coming out of a deferral period. You have to make a decision. Am I going to go into forbearance? Am I going to go into pay-as-you-earn? Am I going to go into income-based repayment? Student loans are changing. Income is changing.
These danger zones are areas where loans are often declined. When you’re moving in between one area and another area with this whirlwind of change, you’re going to see higher rates of underwriter decline. Specifically speaking about med school and the residency, that’s really where the choice is usually made are where we’re going to get into pay-as-you-earn, income-based repayment, or continue to do forbearance.
That’s where loan officers tend to miss this thing a lot because those payments don’t come into repayment until towards the end of the year. If you’re going to finish your med school in May, start your residency in June or July, you’re not going to be forced to make a decision on payments until December usually of that year.
Many loan officers cannot wrap their arms around that change. They misjudge the qualifications, and say someone is qualified when indeed they’re not. With a physician loan, we look at those and we can actually qualify someone either off of no-payment if it’s deferred or in forbearance for long enough.
Alternatively if they’re going to be entering into an income-based repayment or pay-as-you-earn, we can qualify someone off of that payment, even though they’re not enrolled in it yet.
Consider that if you have totally deferred on your loan, and haven’t chosen one of the income based programs, you can still make the choice to start now!
You can possibly avoid some heartache down the road by just enrolling in these programs. If you’re working for a nonprofit right now, you can start that 10 year clock on that Public Service Loan forgiveness program even if you may not qualify down the road.
In order to do so, you’ll need to choose from among IBR, PER, and one of the other income based programs. This will require you to start paying on a monthly basis, but usually the amount is fairly nominal- maybe $200 to $300 a month- it depends on the loan amount and your household income.
Consider that even if you are going not to work for a nonprofit employer, at least your loan balance isn’t getting bigger and bigger and bigger with the $100, $200, or $300 you’re paying towards your loans every month. Simply, get her done and get enrolled in an income based program today!
Tip# 3: What To Look For In Addition To The Good Faith Estimate
Many young physicians aren’t aware of the good faith estimate (GFE) when buying their first home.
It’s a very good document to start with. Your good faith estimate is a statement by the lender which gives to you several promises- a guarantee on the rate, a guarantee on the fees, and a few other important promises.
However, there’s just a lot of questions around this document. The current good faith estimate has some holes in it. It does not show your total payment with mortgage insurance, property taxes, homeowners insurance, and homeowners association dues (if applicable).
It will not show your total cash-to-close. It doesn’t show anything that needs to go to an escrow account for taxes and insurance. It doesn’t show any kind of credits that the seller maybe giving you to cover your closing costs.
The lenders says, “Here’s this official government document, but it doesn’t tell you what your payment is or how much you need to bring to closing.”
That’s the downside of the current good faith estimate.
The upside of that document is it does quantify costs, so when the bank issues you a good faith estimate they are saying, it’s my promise to you.
By October 2015, new requirements roll into effect for this important document. We’re going to get a new good faith estimate. It’s going be five or six pages long and could be very difficult to understand.
We’re told that this good faith estimate will have everything in it but the sun, moon, and stars in it. It will have your total settlement funds to close.
What we suggest is this: get a fee worksheet or a closing worksheet that’s going to approximate your cash-to-close, your credit, your earnest money, the total payment with taxes and insurance, in addition to the guarantees of a good faith estimate.
With those two things together, you can really put the picture in frame in your beautiful new home.
Final Thoughts
As a physician, you’ve made a commitment to helping others and your community.
Now make a plan to put yourself in the best possible position to buy your first home!
Make sure to remember the three keys to unlocking your first home purchase.
First, make sure you are aware of costly insurance that could skyrocket your payments without being tax deductible.
Second, while you are a resident or a fellow, make sure to enroll in an income-based repayment plan of some sort- IBR, PER, or other alternative in order to prevent your debts from getting higher and higher and higher due to the interest compounding.
Lastly, make sure to get a good faith estimate as well as a TOTAL fee worksheet to ensure that you know the true costs of buying your first home and what your monthly payment will be.
If, as a young physician, you focus on these three aspects of a physician mortgage, you will be well down the road to your beautiful new home surrounded by the proverbial white picket fence.
About the Author:
Dave Denniston, Chartered Financial Analyst (CFA), is an author and authority for physicians providing a voice and an advocate for all of the financial issues that doctors deal with. He is the author of 5 Steps to Get out of Debt for Physicians, The Insurance Guide for Doctors, The Tax Reduction Prescription, and his new book, The Freedom Formula for Physicians. For questions about slashing your debt, reducing your taxes, or anything else with a dollar sign in front of it, email Dave at dave@daviddenniston.com or check out his latest podcast at www.DoctorFreedomPodcast.com.
