Here are three critical issues to avoid for physicians to buy a home after residency and facing a mountain of student debt.
If you spend a few minutes in physician chat rooms where the topic focuses on mortgages, you're more than likely to read nightmare after nightmare and horror story after horror story. It's so devastating to see what happens to a crushed home loan and what closing can do to a family.
One time out of the blue, we received a call from a young resident while he was relocating to Utah. The gentleman was working on a home purchase for two months and he was called the day before his closing and two days before he anticipated moving into his home with his wife and two kids.
They were literally driving across the country in a U-Haul truck, and told they were declined for their mortgage loan. He was wrecked. He did not know how to respond to that. He couldn't believe that he could get so deep into a transaction, supposed to have his keys the next day, and move into his home, and at the last minute he was declined.
What we found out is that the loan officer had failed to realize that he had about $170,000 in student loans and they all showed a zero payment. The loan officer made the mistake of just excluding all of that debt from his debt-to-income ratio. When the loan finally made its way to an underwriter, the underwriter had not made the same mistake and eventually declined the loan.
Explore with us three pitfalls that you can implement today in order to make sure that this doesn't happen to you.
Pitfall #1:The Yes Man vs. The No Man
There's a tremendous difference between a mortgage broker and the underwriter. As a matter of fact, there is tension between the two that can lead to these issues.
We call it biggest conflict in mortgage banking.
Quite simply the loan officer is paid to say, "Yes." No loan officer in the country has ever been paid on a loan when they said, "No." In order to get paid, they need to say "Yes."
Think of it as the carrot and the stick.
The conflict arises because the underwriter is the gatekeeper. The underwriter is the quality-control person. The underwriter is responsible, and truly their job and their reputation as a professional underwriter is on the line with every loan that they sign off on.
That's the person who's paid to say, "No." It's not that they want to say no, but it's their job to make certain that everything fits in the box. The income, credit, and down payment have to fit. All those things have to add up and qualify into the underwriting guidelines, and it's at that point where, unfortunately, many physicians are turned down and are now scrambling to find a solution.
Instead, reverse engineer the process to go through underwriting before you write a contract or an offer on a home. This virtually eliminates the chance that you're going to have a problem with the transaction.
Pitfall #2: Renting versus Buying
Most residents and fellows transition out of their residency into fellowship in June and are very eager to buy a new home with their increased income. On the other hand, they want to get out of the mountain of debt hanging over their heads. They grapple with the question, "Should I buy or rent?"
On one hand, interest rates are at historically low rates. It looks great. Yet, if they rent, they can save a good deal of cash flow.
We suggest that you need to be more cautious as you move and get settled into your practice. Consider that in most cases, you have no idea what the heck you are getting into. What if you become unsatisfied with your supervising doc or the practice, or simply don't like the city? Then, you move a few years later - you could lose a lot of money if you are buying and selling homes. In that situation, you are better off renting instead.
Also, consider the market conditions where you are moving. If you're entering a market where there are multiple offers, it's heated. If you can feel there's fierce competition for properties, then that is a market where there is a lot of emotion in that market.
Whenever you're seeing prices outpace rents, your mortgage payments are drastically more than what your rents are, and there is a fierce competition for properties. Those are two signs to be very cautious about, and if you're going to be in a home for a short period of time, you may want to lean towards renting.
Also, think how long you're going to be there. If you're only going to be there two or three years, you might want to consider renting if you're not sure.
However, if you know you're going to be there, you should buy. Consider waiting 6 months and get settled in and get familiar with your area. Just don't wait too long.
Consider this current interest rate environment which most experts say is only going to be going up over the next 5 years to 10 years.
Annually, what would be the average rate you could have gotten each year for the last 30 years had you locked in the 30-year loan? The average is 7.69 percent. In comparison, over the last five years, we've been averaging slightly above 4 percent.
On a $400,000 home, that's a difference of over $12,000 in interest a year. Rising rates could easily add another $1,000 per month to your mortgage payment.
Pitfall #3: Enrollment in an Income-Based Repayment Program
Thinking of rates, the one rate that we see a lot is 6.8 percent with the student loans that a lot of physicians have. Physicians, as they are in and out of residency face choices like income-based repayment (IBR), pay-as-you-earn 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 medical 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 overlook 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 and 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 off of no-payment if it's deferred or in forbearance for long enough.
Alternatively, if they're going to enter 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 the 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 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.
Dave Denniston, CFA, is a professional wealth manager and financial advisor located in Bloomington, Minn. He is also 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. Visit daviddenniston.com/physicians for more information.
Josh Mettle is an industry leading mortgage lender and published author, specializing in financing physicians, dentists, fellows, PhDs, and physician assistants. He is also the author of the new book Why Physician Home Loans Fail. Visit www.utahphysicianhomeloans.com/blog for more information.