Selecting a mortgage can be daunting. Understanding the mortgage terms, the total cost, estimated property taxes and insurance, and the bottom line on a month-to-month expense can be a lot to take in.
For many individuals, utilizing a mortgage to purchase a home can lead to months of underwriting, painful discovery and disclosure of financial documents, and consistently changing deadlines. This process aims to prove that due diligence is completed thoroughly because the mortgage originator will likely sell the mortgage to a servicer after the mortgage is approved.
When a mortgage is sold to a servicer, the mortgagee doesn’t choose which bank purchases the mortgage. The mortgagee is then exposed to a new financial institution without knowledge or consent. What’s even more unfair is the fact that PMI — or private mortgage insurance — is paid by the mortgagee to protect the financial institution if the mortgagee defaults on the loan.
There is a different kind of mortgage available to physicians, called a “physician mortgage” (creative name, right?). A physician mortgage generally forgoes PMI altogether, and this mortgage isn’t sold to a servicer. Instead, the mortgage is serviced by the original lender. The fact that the mortgage isn’t sold to a third party paves the way for the financial institution to make its own rules behind issuing the mortgage.
Since the purpose of the lengthy mortgage underwriting process is to sell the mortgage, the physician mortgage forgoes these requirements, streamlining much of the underwriting requirements. The guidelines of a physician mortgage aren’t standardized, so the rules are determined on a bank-by-bank basis.
Each bank creates its own privately-held set of systems to align with its program. Most physician mortgages offer 100% financing with low costs of mortgage origination, and all that’s required to apply is an executed job contract, even if that contract begins at a future date (such as residents and fellows).
This sounds great, right? There must be a catch!
Yes and no.
The physician mortgage makes it easier, and, often, cheaper to obtain a mortgage, but it can result in a more expensive mortgage. Not necessarily in all cases (since each bank has its own rules), using a physician mortgage can result in a slightly higher interest rate. There is sometimes an interest rate premium on physician mortgages. Normally this interest rate isn’t significant — maybe 0.25% to 0.50% or so, but I’ve seen higher premiums.
While some physician mortgages may offer a 30-year fixed rate, many physician mortgage programs offer an adjustable-rate mortgage, often called an ARM.
Most ARMs are based on 30-year mortgages, but they aren’t fixed for 30 years. Whenever you see the letters ARM in a mortgage, there are two numbers that determine the rules of the ARM. For example, you may see a 7/1 ARM. The first number, 7, means how long the mortgage payment is fixed. For a 7/1 ARM, the payment is fixed for seven years at the stated fixed interest rate, based on a 30-years of payments. The second number, 1, refers to how often the interest rate adjusts, so in this case, once every year. The rate adjustment is almost always based on the “prime” interest rate. So a 7/1 ARM starts with a fixed payment for 7 years, based on a fixed 30-year mortgage; however, after 7 years, the interest rate adjusts once per year based on the prime rate.
ARMs can come in many shapes and sizes, such as 10/1, 15/1, etc. The most dangerous ARMs are the ones that have an interest premium attached to the adjusted rate. For example, the adjusted rate could be loaded with a rate of prime plus 1.5%. This means the adjusted rate on a 7/1 ARM in the eighth year would be the prime rate + 1.5%. Today’s prime rate is around 3.5%, so that would make the adjusted interest 5%. If interest rates increase dramatically, it could inflate your costs.
Not every ARM is bad, and it could result in a lower mortgage rate some years. But as interest rates climb, it could result in higher mortgage payments. The obvious downside to an ARM is the unknown future costs.
The biggest failure I see in obtaining an ARM is simply not understanding how they work, and seven years later, the payment changes (for better or worse) unexpectedly. There are planning considerations with an ARM, just like any other mortgage.
Oftentimes an ARM gets a lower introductory interest rate vs. a 30-year fixed mortgage, so it can be used to purchase a house and then refinance within the next seven years, especially if you are purchasing a house during a time when interest rates seem to be dropping.
If you know you’ll likely pay the entire mortgage early, then an ARM might be somewhat of a non-factor. Often, a physician will purchase a primary residence with an ARM and move to a new house sooner than the ARM fixed rate expires. This usually results in selling the house anyway.
All in all, a physician mortgage is available to physicians to purchase a personal residence. Some physician mortgages are even available for second-home purchases or vacation properties in addition to the personal residence, as it all depends on each bank’s rules. The physician mortgage is not normally available for rental properties, as those purchases generally go through a commercial lending channel.
Which banks have access to physician mortgages? The big national and international banks are not normally going to have these programs available, so if you call a national bank and ask for a physician mortgage, you’ll likely be handed off to a mortgage lender to apply for an FHA loan or a conventional loan.
Local banks are normally the first place to start. I like to compare physician loans and match the program that fits best with each physician. Understanding how these mortgages work along with the culture and expected relationships of the banking service is an important first step to selecting a physician mortgage.
Paul Morton is a certified financial planner.
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