As explained in detail in the "What is a Physician Loan?" section above, all physician loans are conventional loans. You can get them in different terms. The longer the term, the higher the interest rate. 15 year mortgages have a rate that usually is 0.25-0.5% less than the 30 year.

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Adjustable Rate Mortgages (ARMS)

Before I started working with Physicians- I would have never recommended to anyone to get an ARM as a Mortgagee loan officer. Over the years I realized that ARMs have a purpose, and are quite useful in certain situations.

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An ARM is a mortgage that has a fixed rate that is quite a bit lower than a fixed rate mortgagee for a certain fixed term. (5/7/10 years are most common). The notation goes like this

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Fixed year term/year term in which the rate adjusts after the fixed period.

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A 10/1 ARM? Is a mortgage fixed for 10 years and the rate will adjust every year after that.

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The rate on an adjustable rate mortgage compared to a 30 year fixed can be anywhere from 0.25-0.75% less of a rate during the fixed term. This results in a monthly payment that can be a few hundred dollars less than the 30 year fixed option.

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After the fixed period chosen expires- then the rate will change based off a current market index based on a margin agreed upon in the mortgagee paperwork. Traditionally the London Interbank National Rate (LIBOR) Index was used to adjust the rates. There also is usually a "cap" they could adjust your rate per year (EG if market rate was 3% more and you have a 1% cap they can't increase your interest rate more than the cap).

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Most people who get an ARM don't care to understand what happens in the adjustable period because they plan to be out of the house or that mortgage long before the fixed period is over. The only reason someone would not refinance an ARM during the adjustable period is if market rate was much higher than their current adjusted rate.

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When do we see ARMs used?

ARMs are most commonly seen while in training years where pay is minimal and there is a short contract period for employment. In the healthcare feild we see this in residents and fellows who:

1. Have a large amount of debt and make only $50-70,000 during their training years. This makes monthly cashflow tight.

2. On average only are contracted to stay in the place 3-5 years.

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A common situation I see is this:

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An internal medicine resident with a 3 year residency plans to move back home to the south once done with a residency on the west coast. They don't want to purchase a home to set roots down, but to hopefully make some equity back when they sell to move back home. They weigh the pros and cons of buying and decide it is right for them. Then they compare 3 mortgage options.

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1. 0% down physician loan 30 year fixed- Rate 5.75%. 

2. 0% down physician loan 7/1 ARM- Rate 5.25%

3. 0% down physician loan on a 10/1 ARM- Rate 5.5%

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The 7/1 ARM reduces the monthly payment by $300 a month. So he decides to use this mortgage option knowing he will either sell, upgrade, or refinance in the next 3 years anyway, and have more liquid cash during the training years where cash is tight. Even if he adds a fellowship on, he has a buffer of 4 years to make sure he doesn't hit the adjustable period.

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Make sure you understand all the terms of both the fixed and adjustable periods before signing. Also ask if there are "Balloon" payments involved in any ARM you may consider. A "Balloon" payment is essentially when the bank calls whatever the remaining balance left on your mortgage due in a lump sum after a certain period of years. It is common to see a 15 year "balloon" on these ARMS. Meaning if the whole mortgage is not paid off by year 15 you have 3 options

1. Refinance to pay off the old mortgage and get a new one. Ideally you want to time to do this when market rates are lower.

2. Sell the home- pay off the mortgage, keep any equity gleaned.

3. Pay the balance off from your bank account.

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In summary, ARMS can be useful in niche situations as long as you have a plan to be out of them by the end of the fixed term, and are OK with understanding what happens if you step into the adjustable term.

 

If you are extremely risk averse, I would go with the fixed rate mortgage. If you plan to keep a home as an investment, the 30 year fixed is almost always the best option.

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