Can You Use a Personal Loan for a Down Payment on a House?
- Mortgage lenders typically don’t allow you to use a personal loan for a down payment on a house.
- Instead of using a personal loan, it’s cheaper and less risky to save up for a down payment, look for assistance or even apply for a no-down payment home loan like a VA loan.
- If you can’t pay back your personal loan, your credit score will drop and your lender could pursue legal action against you.
Coming up with thousands of dollars for a down payment on a home is a roadblock for many homebuyers. It’s understandable that you might consider using a personal loan to pay for your down payment on your dream home, but lenders typically don’t allow it — and taking on too much debt can land you in financial hot water.
Can you use a personal loan for a down payment?
Mortgage lenders generally don’t accept money from a personal loan to cover a down payment.
A personal loan is a type of installment loan with fixed interest rates, terms and monthly payments. Lenders provide you a lump sum of cash, which you’ll pay off over time in monthly increments. Personal loans are typically unsecured, meaning they don’t require collateral.
Using a personal loan to put money down on a home isn’t a good idea. It will only add to the amount of debt you take on with your new mortgage.
How much you need for a down payment on a house will depend on both the lender and the type of loan you’re taking out. For example, some conventional loan lenders require down payments as low as 3%. According to the latest data from the National Association of Realtors, the average down payment on a home is 10.8%.
Why is it bad to use a personal loan for a down payment on a house?
Borrowing money for a down payment is usually discouraged, and most lenders don’t allow unsecured loans to be used for this purpose. If you’re considering a personal loan as a substitute for saving up for a down payment, consider these drawbacks:
- Higher rates. Even if you have excellent credit, personal loan rates tend to be much higher than current mortgage rates.
- Higher DTI ratio, lower odds of mortgage approval. Mortgage lenders set maximum debt-to-income ratios (DTI). Taking out a personal loan for a down payment could increase your DTI ratio to the point that lenders deny you a mortgage.
- Limits mortgage lender options. Using an unsecured personal loan for a down payment can disqualify you from most mainstream mortgage options. For instance, conventional and FHA loans prohibit consumers from financing a down payment with an unsecured personal loan.
- You may not need a big down payment. It’s a common misconception that you need a 20% down payment for a home. In reality, some lenders allow down payments as low as 3%. If you can’t afford a large down payment, it’s better to put down a small one than to take out a personal loan to finance one.
- You could strain your budget and put your home and credit at risk. Taking on too much debt will make it hard to keep up with payments. Late mortgage payments can damage your credit and put you at risk of losing your home through foreclosure.
Why won’t most mortgage companies let you use a personal loan for a down payment?
A personal loan adds to your monthly payments, increasing your debt-to-income (DTI) ratio — a key factor lenders use to assess your financial readiness for a mortgage. Because a higher DTI makes borrowing riskier, most lenders don’t allow personal loan funds to be used for a down payment. Mortgage lenders view using personal loan funds for a down payment as an increased risk and typically don’t allow it.
How do personal loans affect credit?
Personal loans can both positively and negatively affect your credit. When you apply for a personal loan, lenders run a hard credit pull toward the end of the process to view the history on your credit reports. This can cause a small, temporary drop in your credit score.
As you pay off your personal loan, your credit score could improve over time as your lender reports your on-time payments to the credit bureaus.
What are alternatives to using a personal loan for a down payment?
Using a personal loan for a down payment isn’t the best way to afford a new home. Consider the following ways to get a mortgage without taking on extra debt:
- Save up. It will take time, but saving up for a down payment means spending less money on interest in the long run. Design a budget that prioritizes setting money aside each month. You can make the most of this time by working to improve your credit score to help you qualify for lower mortgage rates when you eventually apply.
- Use a down payment assistance program. Down payment assistance is available to those who are struggling to afford a down payment because of their income. These programs are typically offered by government and nonprofit agencies like the Department of Housing and Urban Development.
- Apply for an FHA, USDA or VA loan. Look for no-down payment home loans or lenders that only require a small down payment. For instance, FHA loans require a minimum 3.5% down payment depending on your credit score, while USDA loans and VA loans typically don’t require a down payment.
Get personal loan offers from up to 5 lenders in minutes