Whether you’ve just completed your residency or been in practice for several years, if you’re in the market for a home, you may instantly gravitate to a 30-year mortgage.
Doing so enables doctors to stretch out a very large debt over the maximum number of years, which results in a lower monthly payment. This is especially helpful for medical professionals still carrying a high burden of student loan debt and/or having little to no money available for a downpayment.
For many, using a 30-year mortgage justifies the purchase of a more expensive house than using a 15-year loan.
But while a 30-year loan saves you in the short term, a 15-year fixed mortgage will likely save you money in the long term because:
- You’ll pay a lower interest rate and less overall in interest payments
- You’ll build equity faster and have more profit once you sell your home
- You likely won’t keep a home for 30 years anyway, especially if it’s your first home
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Consider two new physicians, just out of residency, looking to purchase a $350,000 home. Neither has a downpayment, so they’ll be borrowing the full amount of the home.
Doctor “A” wants a smaller monthly payment, so they opt for a 30-year physician mortgage at 4.25 percent interest. Their monthly principal and interest payment — which doesn’t include taxes, insurance and fees — is $1,722.
During the first year, the monthly payments reduced the principal on the mortgage by less than $6,000. Interest payments on the other hand totaled nearly $15,000.
If Doctor A chooses to sell the home in five years, they will have paid about $71,000 in interest and only $32,200 in principal. They would therefore have equity of $32,200, plus however much the home appreciated in value, at the time of sale.
Doctor “B” went with a 15-year mortgage for the same house with the same downpayment. Only with a 15-year term, the lender offered a 3.875-percent interest rate. The monthly principal and interest payment was $2,567, about $800 more per month than Doctor A spent.
During the first year, the monthly payments reduced the principal on the loan by almost $17,500, or nearly three times the principal paid off after one year on the 30-year mortgage. The interest payments in the first year totaled just over $13,000.
If Doctor B chooses to sell the home in five years, they will have paid roughly $59,000 in interest. With the 15-year mortgage, the amount of principal left on the loan after 10 years would be just over $255,000. That means almost $100,000 plus appreciated home value in equity at the time of sale.
What’s the return on the investment of opting for the 15-year mortgage?
Assuming he/she made minimum monthly payments, Doctor A’s principal and interest payments over five years were $103,320. Doctor B shelled out $154,020 for his/her monthly principal and interest during the same time span. So, Doctor B spent $50,700 more than Doctor A during the five years they owned their homes.
But in exchange for the higher payments, Doctor B pocketed almost $63,000 more in home equity ($95,000 – $32,200) after five years than they would have had with the 30-year mortgage. That’s a return on investment of almost 24 percent.
On the other hand, a disciplined saver can also generate a decent return by opting for the 30-year mortgage instead of a 15-year.
Taking the above example, what would happen if Doctor A saved and/or invested part of the difference in the monthly payment?
Even if Doctor A set aside half the difference ($400) and deposited that amount each month into a savings account, he or she would have saved $24,000 plus accrued interest after five years.
If they invested the money and earned an average annual return of, say, 5 percent, they could have close to $28,000.
By placing the extra money into a tax-qualified retirement account, Doctor A would also benefit by a reduction in their annual tax bill, plus the accumulation of retirement assets due to compounding interest over a several years.
But as stated before, this strategy requires the discipline to not spend the monthly savings on other items.
Many buyers make home purchase decisions based on the monthly payment they can afford. If a $1,700 payment is all their budget can handle, many believe it’s better to get the more expensive home with a 30-year loan than look for a less expensive home financed with a 15-year loan.
But keep in mind that you may not keep the home for the full term of your loan, whether it’s for 15 or 30 years. This is especially true if you’re buying your first home.
Consider that Doctor B from the above example could only afford the $1,700 monthly payment. But instead of choosing the 30-year loan like Doctor A, they decided to buy a less expensive home.
To get that monthly payment on a 15-year mortgage, Doctor B’s could purchase a home for about $240,000. Keep in mind that the lower priced home will likely have lower property taxes and lower insurance costs, meaning the overall monthly payment will be lower than that of the $350,000 home bought with the 30-year mortgage. But for the sake of comparison, assume the two buyers have the same monthly payment.
The buyers of the $240,000 home paid just over $40,000 in interest over five years. But more importantly, they reduced their mortgage balance by $65,000, which added to the home’s appreciated value will be their equity when they go to sell.
The buyers of the $350,000 home, as shown in the above example, have only $32,200 in principal plus however much the home appreciated in value at the time of sale.
So buying the more expensive home with a 30-year mortgage resulted in paying 78 percent more interest and accumulating about half the equity after five years. In all likelihood, the homeowners who settled for less house over a shorter term initially can afford a more expensive home the second time around than the buyers who paid more over 30 years.
Ready for more? Keep reading with:
The Ultimate Guide to Physician Mortgage Loans in 2021
Colin is the Founder & CEO of LeverageRx, an online lending and insurance marketplace for doctors. Colin has over 10 years of experience in financial services and is a licensed life and health insurance agent.