As a physician, you are likely aware of the importance of credit in your personal and professional life. After Silicon Valley Bank’s collapse, there are many headlines about the next big risk for the economy: credit crunch.
The International Monetary Fund (IMF) has warned that credit tightening could throw the global economy into a recession.
From financing your education and starting your practice to purchasing a home and making large investments, accessing credit plays a critical role in your path to financial independence.
In this post, we will explore the concept of credit crunch in more detail, including why it happens, what the impacts are, and what you can do to navigate this challenging economic environment in 2023.
This post was written by Dr. Nirav Shah.
What is Credit Crunch?
Credit crunch refers to a situation where it becomes more difficult for individuals or businesses to obtain loans or credit. This can happen for a variety of reasons, including changes in the economy, shifts in regulatory policies, or changes in lending standards by financial institutions. When credit tightens, it can have significant impacts on the broader economy, affecting both consumers and businesses alike.
Why Does Credit Crunch Happen?
One common reason for credit crunch is a downturn in the economy. When the economy slows down, lenders may become more cautious about extending credit, as they are concerned about borrowers’ ability to repay the loans. This can lead to a reduction in the availability of credit and an increase in the cost of borrowing, which can have a significant impact on businesses and consumers alike.
Another reason for credit crunch is changing in regulatory policies. Governments may introduce new regulations or strengthen existing ones, which can impact the lending industry’s ability to extend credit. For example, after the global financial crisis of 2008, many countries introduced new regulations to make it more difficult for banks to engage in risky lending practices. These regulations made it more difficult for individuals and businesses to access credit, as banks became more cautious in their lending practices.
Finally, credit crunch can also happen due to changes in lending standards by financial institutions. Lenders may become more stringent in their lending standards, requiring higher credit scores, more significant down payments, or stricter income requirements before they will extend credit. This can be a response to changes in the economy or regulatory environment or can be a deliberate strategy by lenders to manage risk in their lending portfolios.
How Do Lenders Tighten Credit?
There are three primary ways lenders can reduce credit availability.
- Debt Service Coverage Ratio: Credit crunch can result in an increased debt service coverage ratio (DSCR), which is a measure of a borrower’s ability to service their debt. DSCR essentially evaluates how much cash flow a borrower needs in order to service the intended debt. When lenders tighten credit, they may require borrowers to have a higher DSCR, meaning that they need to show they have more cash flow available to pay off their debt. This can make it more difficult for borrowers, including physicians, to qualify for loans.
- Interest Rate Spreads: Credit crunch can also lead to increased spreads from treasury rates. When credit is tight, lenders may require a higher interest rate to compensate for the increased risk of lending. This means that borrowers, including physicians, may have to pay more in interest to access the same amount of credit. This can make it more expensive to finance investments, such as purchasing a home or equipment for a medical practice.
- Loan-to-Value: Another impact of credit crunch is decreased loan-to-value (LTV) ratios. LTV is a measure of how much a lender is willing to lend compared to the value of the asset being financed. When credit is tight, lenders may require a lower LTV, meaning that borrowers need to put down a larger down payment to access the same amount of credit. This can make it more difficult for borrowers, including physicians, to access the funds they need to make investments, such as purchasing a practice or equipment.
What Credit Crunch Means for Physicians
Credit crunch can have significant impacts on both individuals and businesses, including physicians.
For individuals, it can mean that they may find it more difficult to access credit, which can make it harder to purchase big-ticket items like homes or cars. It can also make it more challenging to access credit for everyday expenses, which can have an impact on household budgets.
For physicians, credit crunch can be particularly challenging. As you may know, the cost of medical education is significant, and many physicians have substantial student loan debt. Credit crunch can make it more difficult for physicians to access the funds they need to pay off their loans and start their practices. It can also make it more challenging for physicians to invest in their practices, purchase equipment, and hire staff, which can impact their ability to provide quality care to their patients.
Additionally, credit crunch can have implications for investing in categories like real estate where you may want debt to use leverage for an investment.
A Personal Anecdote on Credit Crunch
Recently, I have been looking into purchasing multi-family apartment buildings. Here’s a real quote I got from Freddie and Fannie for agency debt on a building priced at $3.4M:
The required DSCRs are 1.35, up from 1.2 just a year ago. The loan-to-value available is up to 75% , but in this case of 2.3M loan proceeds, it is more like 67% were I to go with Freddie Mac. All of these loan options have spreads above the 7-year treasury, which is how the banks achieve margin.
At the end of the day, this means I can only borrow about $250,000 less than I could have borrowed a year ago!
What Can Physicians Do to Navigate Credit Crunch?
As a physician, there are several things you can do to navigate credit crunch and access the funds you need to achieve your goals.
First, it’s essential to understand the impacts of credit crunch and how it affects your borrowing ability. This means staying informed on market trends, interest rates, and lender requirements. Work with a financial professional who specializes in working with physicians to develop a tailored plan for your financial goals and needs. As much as it is difficult to manage, having a few great service providers in your corner can really help.
Second, focus on improving your financial profile. This includes maintaining a strong credit score, paying down debt, and keeping a low debt-to-income ratio. Lenders will be more willing to work with you if you can demonstrate financial stability and responsibility. Physicians tend to have strong income that is contracted and lenders favor us which gives us an advantage in this coming recession to make savvy purchases over others without a stable income.
Third, explore alternative financing options. This may include working with community banks, credit unions, or non-bank lenders who may have more flexible lending criteria. Consider options such as personal loans or physician-specific lending programs, which may offer more favorable terms and rates. Local lenders such as in the deal I’m looking at are willing to have maximum proceeds at 75% with similar interest rates to the agency debt.
Fourth, be prepared to negotiate. In a credit crunch market, lenders may be more hesitant to lend, but they still want to make loans. Be prepared to discuss your financial profile and negotiate terms that work for both you and the lender.
Finally, be patient and persistent. Navigating credit crunch may take more time and effort than in a more favorable lending environment, but it is still possible to access the funds you need. If you’re looking at purchasing an investment, for example, give yourself extra time. The rate volatility has made it easier to find a swing of 0.5% or more.
In summary, navigating the credit crunch as a physician requires understanding the impacts of the credit crunch, improving your financial profile, exploring alternative financing options, negotiating with lenders, and being patient and persistent.
By taking these steps, you can access the funds you need to achieve your financial goals.