Can You Use a Personal Loan for a Down Payment on a House?
Affording the thousands of dollars required for a down payment on a home can be a roadblock for many consumers.
If you’re house shopping and money is tight, you may consider alternative measures like taking out a personal loan. However, using a personal loan for a down payment on a house is an approach that many mortgage lenders won’t view favorably.
Here’s what you need to know about down payments and personal loans.
Can you use a personal loan for a down payment?
In many cases, mortgage lenders won’t accept funds 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, then, over time, you’ll pay it off in monthly increments. Personal loans are typically unsecured.
But while some lenders may allow you to use a personal loan to put money down on a home, it might not be a good idea to adopt this strategy, since it adds to the amount of debt you’re taking on.
How much do you need for a house down payment?>
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 National Association of Realtors, the average down payment for first-time homebuyers is between 6% to 7%.
Why is it bad to use a personal loan for a down payment on a house?
Borrowing money for a down payment isn’t a good idea and generally isn’t possible with many lenders. If you’re considering a personal loan as a substitute for saving up for a down payment, consider these drawbacks:
- Mortgage interest rates are more competitive. Even if you have excellent credit, if you take out a personal loan, you’ll likely pay much more in interest compared to current mortgage rates.
- It’ll increase your DTI. Mortgage lenders typically require you to have a debt-to-income ratio (DTI) that’s lower than 43%. Taking out a personal loan for a down payment will increase your DTI ratio to the point where you could no longer be eligible with some lenders.
- Loan options are limited. Using a personal loan to cover your down payment will significantly narrow your lender options. For instance, conventional and FHA loans prohibit consumers from financing a down payment with an unsecured personal loan.
- A large down payment may not be required. A common misconception among consumers is that you need to provide a 20% down payment for a home. This is untrue, as some lenders allow for down payments as low as 3%.
- It could strain your budget. Taking on too much debt could severely stretch your paycheck and make it difficult to keep up with payments. Late mortgage payments can not only drag down your credit score, it can also put you at risk of losing your home through a foreclosure.
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. Unfortunately, this can cause your credit score to drop by up to 5 points and can stay on your credit report for up to two years.
However, as you pay off the personal loan, your lender can report those payments to the credit bureaus which can help improve your credit score over time.
What are alternatives to using a personal loan for a down payment?
Taking out a personal loan for a down payment isn’t the best route for buying a new home. Instead, explore these other routes that can help you afford a mortgage without taking on extra debt:
- Increase your savings. It may be worth it to hold off on buying a house and save for a down payment. Craft a budget specifically geared to prioritize setting more money aside. It may also be worth it to improve your credit score during this time to help you access lower rates.
- 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. For instance, you can apply for a down payment grant through the Department of Housing and Urban Development.
- Apply for an FHA, USDA or VA loan. It’s a good idea to shop around and find no-down payment home loans or lenders that only require a small down payment. FHA loans require a minimum 3.5% down payment (depending on your credit score) while USDA loans and VA loans typically don’t require any down payments.
- Borrow from friends or family. Family loans can save you money on interest and fees, but be sure to come up with a repayment agreement. Note that your mortgage lender may ask about any large deposits in your bank account, so you might need to explain or even offer a payment plan. If your loved one gives you the money, they will likely have to provide your lender with a gift letter.