Despite only owning two homes, we’ve cycled through multiple loan types, covering the gamut of what most doctor’s (and non-physicians) will consider when buying their primary residence. We bought once, at the bottom of the market (2010), and again at the top of the market (2016), with a few re-fi’s thrown in for good measure.
So here is the backstory to our decisions to buy/sell and how to finance the homes. Some of these situations will probably be familiar to you, and I hope it’ll help inform your own decisions in the future. .
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Private Mortgage Insurance (PMI): if you try to obtain a home loan with a down payment smaller than 20%, most lenders charge PMI. This is an extra fee (usually monthly) on top of your loan, giving them compensation for the additional risk they take on. In the past you could eliminate the PMI fee once you reached ~20% equity, but that has become disallowed in some loans (such as FHA loans).
Doctor’s Loans: physicians have low rate of defaulting on mortgages. Once you get into residency, barring death/disability/criminal behavior/pure incompetence, you generally will have a reasonable to great income (as long as you want to work). So with a doctor’s loan you are not charged PMI, though you may have a higher interest rate (that is still less than PMI). You can obtain a doctor’s loan, in certain circumstance, with no downpayment. Some non-physicians (such as dentists) can also obtain this type of loan. This was popularized by Bank of America.
Jumbo loan — a loan with a value more than $424,100. Generally requires a higher interest rate.
The Great Recession
In early 2010 I had almost 3 years remaining in a 3.5 year fellowship (yes, I added 6 months). My wife was halfway through her pediatric nurse practitioner (PNP) program. We had one child and a small amount of student loan debt (mine). We were renting a house in a wonderful location: safe, walkable, easy access to public transportation for both of us to get to work AND to highways to drive.
Except — the house was terrible, and the landlord was worse. Tired of the bugs and wind blowing through the living room, we decided to move (during my residency we rented a fancy apartment a few blocks from the hospital in Houston where we worked). Instead of renting again elsewhere, we (or perhaps my wife), decided it was time to buy a home.
The great recession was under way and home prices were low. We had a limited budget; we had an emergency fund, but only limited savings for a downpayment.
I can’t say we spent a lot of time discussing it. The White Coat Investor website did not yet exist. It’s possible we would have made a different decision had we thought about it from a purely financial standpoint.
After a long search, we found a home that seemed to be in our budget. It was slightly over the initial price range we set, but the homes in our initial range were so bad we bumped up higher than planned to find something decent.
It was in the city, close to work, in a family friendly area, and walkable to restaurants, a park, a library (and the best Target ever).
The Doctor’s Loan
Bank of America had stopped offering their doctor’s loan, so I was in our search of others to help finance the home. These loans are now widely available in different forms from many lenders, including BOA. Check out this page from The White Coat Investor for a great list.
I discovered Colorado State Bank & Trust, a subsidiary of Bank of Oklahoma, still offered doctor’s loans. We arranged out financing through them and did everything by email/fax/phone. We never met the lender in person and we had no issues.
We set up a 100% loan-to-value (LTV) mortgage — i.e. no downpayment — with no PMI. We had a 7-year adjustable rate mortgage around 4.5%, with a term to pay off the loan over 30-years. The interest rate would fixed for the first 7-years, then go up or down depending on the market rates.
Once variable rate loans reach the point of fluctuating rates, the loan terms have limits written in, limiting the amount up/down they can go each year (yes, it can go down, though don’t count on it). A 3% rate can’t jump to 10% in a single year; look at your paperwork CLOSELY to determine your adjustments if you sign one of these, and plan for these in advance.
The rate on the 7-year ARM is lower than on “fixed” mortgages, where the interest rate is constant through the life of the mortgage. Banks want to get you when the rates go up, later in the life of the loan.
- Home prices had tanked and rates were low, so even with no money down we could get a decent home at a payment that was similar to our rent.
- My wife would be a PNP with a plan for a higher income 1.5 years later, and in 2.5 years I would be an attending physician with a much higher salary. If we stayed in the home, the payment would be very small compared to our combined income.
- We bought a home we could potentially stay in for several years, even after I was an attending. It had room for an extra child, should one come along.
- Mortgage rates were so low and the economy so bad that we were not highly concerned about rates jumping quickly, giving us time to refinance to a fixed-rate mortgage if needed.
- The seller gave us a home warranty that would cover major repair issues in the first year.
- We were home owners! We had control over our dwelling and could do what we wanted with our living space; over time it’s a way to build net worth.
- With 0% down and a 30-year term, a TON of money the first few years goes to interest, so we we would be building very little equity in the home. Also, we were probably underwater the moment we purchased it.
- If we moved, selling the house may have been difficult given the housing market, and we may have had to bring cash to the table to cover the mortgage if the home value declined.
- We bought a home with less than 3 years left in my training and in a terrible housing market. We did not yet know if we would be staying in town for my first job after training
- My wife was 1.5 years away from a higher income, and I was 2.5 years away, so we had awhile before our income would easily cover the extra costs of home ownership.
- The home loan had a 30-year term, so if we took it to the full thirty years to pay off, we would be facing significant interest rate risk over the life of the loan.
- The home was 80 years old, so the potential for expensive things breaking was real. We paid for a second year of the home warranty, because for some reason I’m a sucker for warranties. Reliance on warranties may be a sign of cash flow paranoia, of which I am occasionally guilty.
Buying a home when you know your job ends in 2.5 years is a bit risky.
I “knew” I would be able to secure a attending physician job in town, but I may not have wanted them. Ultimately we did choose to stay in town after my fellowship. Owning the home was not a major factor, but it did make us feel a bit more rooted. That’s not a bad thing; it’s my home town where my parents are and not far from my in-laws. They’re happy we stayed!
The market was probably the ideal circumstance for a 0% downpayment loan. Being closer to our income increases would have better equipped us to handle the cost of owning a home, but we made it work. In a competitive market, those paying all cash or with secure finances will be at an advantage.
Refinancing and Paying PMI Upfront
Less than after our initial purchase later, interest rates had dropped, so I looked to refinance.
We did not have 20% equity, and as you generally can’t refinance into a doctor’s loan, we would have to get go a more conventional loan via a mortgage broker. This also meant we had to worry about now being charged PMI, as we did not have 20% equity; without that amount of equity, we would be charged PMI.
The home appraised a little higher than our purchase price, giving us a few percent in equity and making it easier to do the refi.
Apparently it helps if you say something to the effect of, “we’re really hoping the house appraises around $’x'” when the appraiser shows up. Yes, we were advised to say that. Yes, I said it. Yes, the number ended up fairly close to my wish. No, I have no idea if it actually mattered. It did not hurt.
The rate drop with a shorter loan term meant less interest, making the math work to stomach the PMI fee. Instead of paying PMI monthly, we paid a smaller total amount as a single upfront payment. This upfront PMI payment was tax-deductible.
Paying PMI as an upfront fee is not common. While the math seemed to make sense at the time, I think it may have been the wrong decision.
We likely could have paid less in monthly PMI by paying extra to get to 20% equity; once reached, we could have dropped the monthly PMI fee, or refinanced again to another loan to remove the PMI (if rates dropped again).
- Lower rate means more $ to equity
- Still subject to risk if we hold onto the loan and interest rates begin rise
- Paid a lump sum PMI, may not have been necessary
Rates Drop Again and the 15-Year Fixed
The following year, my wife became a PNP, working full-time, with a significant bump in income when she transitioned from part-time at a lower paying position to full-time at a higher paying position.
Interest rates had dropped again, and my student loans had unexpectedly entered an interest free deferment when I started a post-doctoral program and Master’s program. So our cash flow was significantly improved.
Thus, we re-financed again — this time to a a 15-year fixed. Home prices had started to increase a little, giving us a bit more equity based on the appraisal, and letting us avoid PMI. We also had some cash to bring to help get to 20% equity for the loan.
The rate was the lowest of all, and while the monthly payment bumped, it was manageable.
- Lots of money to equity and very little to interest — best case scenario
- Loan paid off relatively quickly
- No market risk if interest rates change
- No significant ones
- Less disposable income, but not an issue where we were financially.
- If we needed to move (if I did not stay as faculty) and couldn’t sell the home, the higher monthly payment would’ve been harder to manage, as renters may not have covered the payment completely. We may have had to refinance again to a longer-term to lower the payment.
Living Like a Resident, The Attending Home, and the Jumbo Loan
I accepted a faculty job at my same institution, so in Jan 2013 my pay bumped; Rogue Two joined us later that year.
In 2016 our finances were on a nice trajectory, with a high saving rate, student loans paid off, and saving for the future “attending” home.
It was then that we learned Rogue Three would be joining us. We had envisioned a move within a few years, but this accelerated our plan as there was literally nowhere to stick a baby.
So we looked for the “attending” home — a bigger/nicer home, in a good public school district (as opposed to the city/charter schools we had access to in the city, of variable quality), that would leverage my higher income as an attending.
While we sold our first home near the top of the market, we were also buying near the top. Decent homes were going in a couple weeks, good ones in a few days, and very desirable ones in the first day. We had been saving aggressively with this purchase planned, but we thought we had more time, and we were buying at a bad time.
We found a home where we could put a 20% downpayment without using the equity from the first home, but because of the price, had to use a jumbo loan to finance the purchase. With the spectre of significantly higher expenses, both from the home but also from childcare, and knowing my wife may want to go part-time at some point, we chose to do a 30-year loan at 3.5%. The interest rate on a 15-year loan was only 3.25%, not significantly better.
- We had “lived like a resident” for a few years, allowing us to aggressively save a downpayment for this purchase, only 3 years after I completed training.
- Mortgage was less than 2x our combined income, a good rule of thumb to decide how affordable it is. Some advisors/brokers say it’s fine to get a mortgage 3x your income, but that’s crazy unless you’re in a place like San Fran, NYC, etc, where prices are not logical. We are in the Midwest
- We could stay in this home forever, if we desire to do so. Our first home always had an expiration on it because of space and schools.
- The 30-year term meant a lower payment, giving more month to month flexibility should we need it — turns out, we needed it.
- Our daycare expenses went up about ~150% after the new baby.
- We had to unexpectedly switch from the subsidized hospital daycare to a fancy-pants expensive one in the suburbs near the new home. We went from one kid at a cheap daycare to two kids at an expensive one.
- My wife did go part-time middle of 2017, cutting 40% of her hours (and of her income)
- The 30-year term means lots and lots and lots of interest the first several years, and not much equity being built.
- It’s going to take 30-years to pay off (duh), unless we accelerate our payments. I don’t want to be paying this thing off when I’m Medicare eligible (which will happen the final year of the loan); I’m debt averse, so really want to remedy this.
- The new tax law makes our mortgage interest deduction less valuable (not that I knew this was coming in June, 2016). For the 2017 tax return we’ll see the full value of the deduction, but it’ll be less helpful starting with the 2018 return. This will impact many future home purchases as well as home values, potentially mine as well.
That’s the current state of our journey. Let me know what I missed and your own thoughts and experiences!