By Dr. James M. Dahle, WCI Founder
Leti and Kenji at SemiRetiredMD ran a post a while back answering a question I often get: “Can I use a doctor loan to buy an investment property?” They correctly answered the question that, in general, you can't do that. Then, they pointed out a handful of ways that one possibly could do it and suggested some people from our recommended physician mortgage lender list that could help. I had some issues with the article, though. It wasn't that anything in the article was factually wrong. It was the fact that the article didn't address the elephant in the room, which is the question that should have been asked,
“Should I use a doctor loan to finance an investment property?”
The answer to that is almost always going to be no, but if you read that article, you would likely come away with the impression that the answer should usually be yes. Let me explain what I mean.
What Are Doctor Loans?
First, it's important to understand what a doctor or physician mortgage loan is. This is a mortgage loan you can get that allows you to buy a house with less than 20% down and NOT PAY Private Mortgage Insurance (PMI). Remember PMI is that insurance that you pay to protect your lender from you defaulting on your mortgage. It's a nice benefit to not have to pay it.
In addition, these loans will generally only consider your required student loan payment (rather than your true debt-to-income ratio) so, if you are in an Income-Driven Repayment (IDR) program, you can still usually get a mortgage even with a massive student loan burden.
Finally, a doctor mortgage can generally be underwritten based on a contract without requiring several months of actual paystubs. So, you can get the house before you start your job.
Why Would You Want to Use Doctor Loans?
Why would someone want to use these loans? Usually, it's because they are in a rush to buy a house. Frankly, by the time you are really in a position to buy that dream house of yours, you've got your student loans well under control, if not paid off completely (live like a resident); you know your job likes you and you like your job (and thus have 6-12 pay stubs); and you have a 20% down payment saved up. You can simply use a conventional mortgage and take advantage of its typically lower rates and fees.
But after deferring gratification for 10-15 years, many of us are in a bit of a rush and we often have a much better use for our money than a down payment, such as maxing out retirement accounts or paying off student loans. I'm not necessarily against doctor mortgages, but I think most people ought to at least consider saving up a real down payment and delaying that purchase, especially if you're looking at getting that dream house right out of residency (or worse, buying a house during a short residency).
An Unacceptable Level of Risk
So, if I'm OK with physician loans and I like real estate investments, what's the problem? The problem is that using a physician loan to buy an investment property generally brings an unacceptable level of financial risk into your life.
The math is pretty simple when it comes to buying investment properties. If the cash flow is positive, meaning the actual rent received is always more than the costs of the property, then you can own an infinite number of properties without ever running out of cash.
But if the cash flow is negative, then you are limited to a handful of investment properties, and that's if you are willing to dedicate a significant portion of your earned income to “feeding the beast” of those negative cash flow properties.
What is the best way to ensure your investment property will have positive cash flow? Put down 25-35% in cash. And if you're going to do that, you don't need a physician mortgage.
Remember that rent is not guaranteed. Consider the recent pandemic. One-third of rental payments nationwide were not made in April 2020. How many months of that can a highly-leveraged landlord take? Not very many. But a less-leveraged landlord with significant cash reserves can last a lot longer in a downturn without having to firesale properties (or start picking up extra shifts).
If you're only going to put down 0%-5% on an investment property, you better be getting such a sweet deal on the purchase that it will have positive cash flow anyway. That means you basically created 20%-30%+ of instant equity when you purchased and/or cheaply renovated it. That is a lot harder to do than most of the “Buy Houses with Nothing Down” books would lead you to believe.
The Scenarios
Now, let's go through the various scenarios proposed in the article using physician loans to buy investment properties and point out some of the risks of doing so.
#1 Buy a Duplex and Live on One Side (While Renting Out the Other)
This isn't necessarily crazy, but it mixes business with pleasure. Lots of residents buy houses thinking they'll rent them out as a sweet rental property when they move out. But they don't go into the purchase thinking like a landlord. They go into it thinking like a homeowner. Homeowners care about colors, backyards, neighbors, commute length, etc. Landlords care about the cold, hard numbers:
- What will it rent for?
- What will the expenses be?
- What is the cap rate?
- What is the net operating income?
If you buy your duplex thinking like a homeowner, it likely won't be a great rental. If you buy it thinking like a landlord, it likely won't be a very satisfactory residence. Maybe you'll get lucky, but I wouldn't count on it.
#2 Buy a House, Live in It a While, Then Move Out and Rent It Out
Here's another scenario. You buy a house, live in it for a year or two (or, more likely, 3-5 years until you get out of residency) and then rent it out while buying another (perhaps with another doctor loan). A few lenders in some states will let you do this. But you still have the same problem. The mortgage is too high to allow the property to have positive cash flow. That rental isn't a blessing in your life and an asset on your balance sheet. It's a curse in your life and a liability on your balance sheet.
#3 House-Hacking
This is where you buy a home with a doctor loan and then rent out the bedrooms. Did I mention you're a doctor? Leti and Kenji suggest this as an option during medical school or residency, but I challenge them to find a lender that offers doctor loans to medical students. I don't know of one.
That leaves residency, maybe. Do you really want to work an 80-hour week and then come home to deal with issues with your tenants/roommates? If you think landlording is tough, trying living with the tenants. Especially if you have a partner. Or children. Or work long hours. Or are trying to sleep after a long call or overnight shift. Sounds like a good way to flunk out of residency to me, and that's assuming you can pack enough roommates in and charge them enough to provide positive cash flow. More likely, you'll find you're using a significant chunk of your limited residency salary to keep the whole thing going until you are rescued by your attending income. But you wouldn't know it from the article:
“The potential benefit of house hacking is obvious. Assuming you do it the right way, you could buy a property with no money down, live rent-free, and make an income.”
So, now you not only have to have positive cash flow, but you have to have so much positive cash flow that it covers your share of the expenses and provides additional income? Good luck. Remember you can't rent out the room you are living in! You better be going over your numbers with a fine-toothed comb (and have the rental contracts all lined up) if you think this is going to work out for you. It won't most of the time, especially after subtracting out the value of your time.
#4 Airbnb
Yet another strategy . . . instead of going into the landlording business while in residency, go into the hotel business. I'm sure your attending won't mind if you take a call in the middle of rounds to line up this weekend's guests. Being an Airbnb Host seemed so smart back in January 2020. It didn't seem so smart in April 2020. Like with most things in investing, the potential rewards are higher because the risks and the amount of work required are higher.
Risks to This Strategy
To be fair, the article eventually acknowledged these risks to this strategy, but it continued to downplay them:
“There aren’t many downsides to using a doctor loan to house hack . . . One potential downside is that you may not cashflow as well with no money down because you’re borrowing a larger amount than you would normally . . . However, this can be balanced out by self-managing, which will lower your expenses significantly. You can lower costs even further by handling minor repairs and doing your own yard maintenance/snow removal.
It doesn't matter how many there are if they are big risks. Did I mention you're a doctor and your time at work is worth $100-$400/hour? That you went to medical school to doctor, not landlord?
“Also, any downside is far outweighed by the fact that you can start investing much earlier than you would have if you waited until after finishing your training. Not only do you start gaining valuable experience and real-life education, starting earlier means you benefit from the power of compounding to build your wealth even faster.”
As Ecclesiastes reminds us, there is a time and place for everything. Getting the cart before the horse is a serious risk here. I mean, if you really need to have a dozen rental properties by the time you're 35, why did you waste all that time in medical school and residency? You missed out on all that valuable experience and real-life education while you were learning the Krebs Cycle and battling EMRs. There will be plenty of time to be a successful real estate investor and reach FI by mid-career without having to use a doctor mortgage to buy your first investment property. Slow down!
Slow down and reduce your risk. It's much more relaxing.
“Another potential downside of putting less money down is that there may be a greater risk. By that, I mean, if there’s a downturn, you may have less equity in your property. So, if you need to sell it and move on, you might end up coming out of pocket to get rid of your property. This is especially applicable to single-family homes . . . However, you can completely mitigate this risk by buying the property the right way. This means that you do your analysis upfront, taking into account various issues that might come up and ensuring that your property continues to cashflow even if you run into some misfortune.”
Greater risk? You think? Yes, I agree that you should do your analyses up front . . . and make sure you take into account a global coronavirus pandemic. Oh, you didn't think of that? That's what risk is . . . the stuff you didn't, or even couldn't, think about.
Leverage introduces risk. Lots of leverage introduces significant risk. Infinite leverage (i.e. 0% down) introduces unmanageable risk. Don't take risks you don't need to take to reach your financial goals. In most cases, that includes using a doctor mortgage to finance an investment property.
What do you think? Would you use a doctor loan to buy an investment property? Why or why not? Comment below!
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I think this post is a very important rebuttal. This is not a risk that I would be willing to take as I continue to invest in real estate. It’s certainly not something I would have done in training. Training is a time to focus on becoming the best doctor you can. While I’m a HUGE proponent of minding your finances during this time, I think it should be via simple habits that lead to big results with minimal risk and set the stage for long term habits.
Enjoyed the post!
I think you’re a little too harsh on #1. If you’re living like a resident anyways, you’re in a rental type place and not a forever home. You can find a property manager who will take 10% of monthly rents. It reduces the profitability, but I’m guessing the numbers are still better than renting a single family home, owning a single family home, or renting a duplex unit from someone else
I agree you’d have to run the numbers.
I am a doc who diversified into various investment buckets. Tax deferred, taxable, and real estate are all significant and have made substantial contributions to our growing net worth. Taxable and tax deferred accounts are great for simplicity, ease of investing, and slow wealth building.
The real estate is different. The downsides are you need to spend time learning how to invest well. Learning how to invest in real estate is a lot easier than going to med school, but there is definitely a learning curve if you want to do it well. And there are as many bad real estate investments out there as there are good ones. Despite the real estate sector downsides, there are many upsides as well. The tax benefits, depending on how you structure things, can be substantial. Our plan in 2021 is to save huge amounts on income taxes through additional cash flowing real estate investments. The other investment buckets of tax deferred and taxable investments are already substantial at this point, but the tax free cash flow from the real estate investments provides far more regular monthly income than any dividend earnings on equities. We have enough excess cash flow that only the steepest of downturns, something like the great depression, might lead to a negative outcome.
It’s been awhile since buying properties, but residential loan applications typically had a declaration that you expected to live in the home as your primary residence. I can’t imagine that’s changed or any reason doctor loans wouldn’t include the same clause. After all, it’s just a residential mortgage with attractive terms.
| There aren’t many downsides to using a doctor loan to house hack
Which leads directly to the two most obvious risks. The lender discovers the house hack and immediately calls the loan due since the borrower has violated the terms of the agreement. Whether that’s better or worse than being charged with loan fraud because the lender is having a bad day is arguable. Those two items should always be first and foremost when deciding to play real estate financing games relying on traditional lenders.
How would they ever find out? I’ve heard plenty of Air BnB hosts getting shut down and fined by HOAs / property management companies / local government by simply looking up property addresses for rent in the area. If it’s being promoted publicly, it’s easy to find.
I’m not a doctor but I’m doing something similar right now with a VA loan. I’m using a VA loan to buy a triplex with only 5%. down. The property would cash flow with only 5% down based on full occupancy, as my 30 year mortgage rate would be 2.25%. I have enough assets and cash such that I could put 20% down if I wanted to sell stocks and other assets that earn a higher return but I’d rather borrow the money at 2.25%. (I’m planning to move into one of the units, once escrow closes and the pandemic permits, so it won’t cash flow then.)
I agree that using a doctor’s loan to buy multifamily without assets to protect against challenges with renting would be too risky. Given today’s extremely low interest rates though, I think using a doctor’s loan, or a VA loan, i.e. loans that allow for purchase with 0% down and no PMI, can be an appropriate leverage tool. But the numbers and having sufficient assets to protect against lack of rent are key.
You know you can’t use a VA loan for a property you’re not going to live in right?
https://www.veteranloancenter.com/handbook/investment-property/#:~:text=VA%20Loans%20can%20be%20used,purchase%20investment%20property%20or%20land.
Yes, I’m going to live in the property. Thus my comment (I’m going to move into one of the units…)
My comment addressed the cash flow based on it’s current full occupancy because that makes the analysis of it as a rental property simplest. But it will be a mixed primary residence / investment property once I move in. I believe the primary residence requirement is the same for doctor’s loans?
Yes.
It sounded from your first comment that you weren’t going to move in for a while or you were moving in as an afterthought.
Pandemic eviction restrictions may cause some delays.
Ultimately, buying multifamily where the buyer intends to occupy has to be evaluated both as an investment property and as a primary residence.
Agreed. Tricky to have it work out for both purposes.
Hey, might wanna let your mods know that cussing, personal attacks, and political rants are not OK………..
Not sure what you’re referring to (blog comments, WCI forum, subreddit, FB group) but when you see a post that is breaking rules, just flag it for moderators.
I think this post was a nice dose of sanity following the endless bull market that real estate has had the past ten years.
I appreciate what Leti and Kenji are doing, but the thing that drives me nuts is that the majority of their “super acceleration” schitck is based off the forced depreciation loophole from TCJA that is phasing out in the next year…. How has no one pointed that out? Meanwhile they are selling coaching for thousands of dollars a pop. By the time all their students get a portfolio large enough to cut back from clinical medicine and become a full time real estate person, that benefit will be gone.
The bonus depreciation deductions are currently scheduled to slowly phase out beginning in 2023. The tax laws could change, but for now those tax deductions remain for the 2021 and 2022 tax years. Based on current tax law, we are planning on getting 2M worth of deductions from bonus depreciation in 2021.
It’s definitely hard to make long term plans around future tax law. As a general rule, it’s probably best to make decisions assuming current law endures indefinitely since it is usually just as likely to change one way as the other. But when there is a definite phaseout coming (bonus depreciation, 199A deduction) it seems some weight should be given to that change in current decision making, and the closer you get to it the more weight you should give it. But how much weight is right? That’s a judgment call.
We “house hacked” our way through residency, and it’s the reason I was able to pay off my loans so quickly. Many of the objections to house hacking just didn’t materialize — we would typically buy duplexes and rent out the other half, and the noise levels/inconvenience of shared space were minimal. Additionally, my husband was non-medical, and was able to manage the tenants easily, freeing me up to focus on residency. Since we were using it as our primary residence, there was never a problem with the lenders. Instead of paying $1200/mo for rent, we paid $250/mo of the mortgage and the renters covered the rest. We’ve been able to keep the properties and continue renting them and they have appreciated well. I couldn’t recommend house hacking enough for new residents!
Glad it worked out well for you, but for every doc for whom it works out well, there are more that it works out poorly. No appreciation during residency, can’t sell it when they leave, long-distance landlording, feeding the beast every month etc.
I couldn’t disagree with this post more. I bought two homes in residency with “physician loans.” Since these are portfolio loans, the individual banks were willing to do two loans simultaneously. I house hacked 2 duplexes in my residency in Michigan, living in each one as my primary residence for over a year, satisfying the “primary residence” terms of the loan. Both duplexes were very pleasant places to live, and my quality of life was similar to other residents. On average, I paid $150/mo of the mortgage, and the renters covered the rest. Both houses have appreciated considerably. I have financial freedom now that I never would have had if I hadn’t used physician loans to buy investment properties.
The writer conflates cash flow and equity in the beginning which makes me discount other sections of this article. Cash flow is generated from assets has nothing to do with equity unless your saying it’s part of your retained earnings. But in this case talking about the equity in an asset and drawing a parallel to cash flow is aggravatingly wrong.
It would be absolutely brilliant to use someone else’s money with no money down to fund the purchase of investment property. Here’s why….
1. You can save your down payment as an emergency fund to fund what you noted as negative cash flow issues if they arise. (Also known as funding cash burn)
2. Show of hands what doctor wants to work 24 hours a day 7 days a week to generate cash flow when you can have an asset that generates it for you?
3. Regarding the time management issue, one can hire a property manager to manage the property. If the goal is to build wealth you should be more interested in the terminal value of the asset and the exit strategy. If managed correctly it will pay for it self and build equity over time.
The commenter apparently does that realize that the more you put down, the more equity you have, and the smaller your mortgage and thus the better your cash flow. Thus, equity and cash flow are related and thus discussing them together is not “aggravatingly wrong.”
1. Is an excellent point.
2. Is a straw man argument
3. Contains obvious statements but “aggravatingly wrongly” says a property can pay for itself if you would just manage it correctly. That’s not the case when the mortgage payment and other expenses are more than the gross income of the property. No management tricks will make that property cash flow. You either need to buy better or put more money down.