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Can You Use a Personal Loan for a Home Down Payment?

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Buying a home can sometimes be an intimidating financial undertaking, especially since you have to spend thousands of dollars on a mortgage down payment. If you’re looking for ways to afford a down payment, you may have considered taking out a personal loan.

Most of the time, you can’t use a personal loan for a home down payment. Conventional and FHA mortgages prohibit the use of personal loans as a source for down payments. Even if you can find a lender that will allow you to use a personal loan, it is unlikely to be your best option for a down payment.

Why a personal loan for a home down payment could be unwise

A personal loan is a fixed-rate installment loan that borrowers repay in equal monthly payments over a set period of time, typically one to seven years. Personal loans can be a good tool in some situations, such as consolidating credit card debt, but they’re not a good option for financing a mortgage down payment.

Using a personal loan for a mortgage down payment isn’t even possible in most cases. On the off chance that you’re able to use a personal loan for your down payment (such as if you go through an alternative mortgage program that isn’t backed by Fannie Mae), it’s still not typically advisable. Here’s why:

  It limits loan options. Using a personal loan for a down payment disqualifies you from taking out an FHA or a conventional loan.

  You don’t need 20% down to buy a house. Competitive interest rates are available for buyers who can put as little as 3% down on a house.

  It could lower your credit score. You want your credit to be in top form when applying for a mortgage, but applying for credit or taking out a new personal loan can lower your credit score — at least initially.

  Homeownership can often be expensive. Adding a personal loan payment to a new mortgage payment may leave you feeling tight on cash.

  Interest rates are comparatively high. Even borrowers with excellent credit will not be able to secure a personal loan interest rate that’s lower than the current 30-year mortgage interest rate.

What to consider when borrowing a personal loan

By now, you know that using a personal loan shouldn’t be your first choice when looking for a way to make a down payment on a mortgage. But if you still prefer this route and you find a mortgage lender who will allow it, it’s important to prequalify for personal loans so that you can find the best possible deal for your financial situation.

Here’s what you should consider when searching for a personal loan:

  • Shop around to find the lowest annual percentage rate (APR) on a personal loan. The APR is the total cost of borrowing money when fees are included.
  • Fees and penalties. Some lenders charge fees, such as origination fees and prepayment penalties. Origination fees are typically 1% to 8% of the loan balance. While many lenders don’t charge a prepayment penalty for paying off your loan early, some do.
  • Minimum credit requirements. Some lenders have strict credit score requirements for borrowers, while others are more lenient. In general, the higher your credit score, the more competitive your interest rate could be.
  • Monthly payments. Since you’ll pay the personal loan payment along with a new mortgage, it’s important to keep your monthly payment reasonable.

How to obtain a mortgage if you can’t afford a down payment

Purchasing a home is a significant financial commitment, so you shouldn’t make the leap if you aren’t financially prepared to make a down payment. Your first choice for down payment funding should be to budget in advance and pay out of your savings. If that’s not an option for you, consider some of these alternative ways to afford a mortgage down payment:

See if you qualify for down payment assistance programs

Down payment assistance programs aim to help those with low or moderate incomes buy their first home. Issued through a government or nonprofit agency, these programs offer grants or second mortgages that can help you buy a home without a huge down payment.

You can learn more about down payment grants through the Department of Housing and Urban Development, or search for local down payment assistance programs offered in your area.

Look into FHA loans, USDA loans and VA loans

FHA loans are best known as first-time homebuyer loans. However, these loans, which only require a 3.5% down payment, offer excellent terms for anyone struggling to save up a large down payment. They are also a great option for borrowers who have subprime credit.

USDA loans are zero-down home loans for people living in rural areas. To qualify, you must buy a house in a qualifying area and be the primary occupant of the house. These mortgages come with a modest 1% upfront fee, and a 0.35% annual fee.

A VA mortgage is a benefit for military service members, including members of the National Guard and reservists. It allows borrowers to take out a mortgage with a 0% down payment. The loan’s upfront funding fee can add up to 3.6% to the cost of the principal balance of the mortgage, but the funding fee and other closing costs can be added to the mortgage.

Seek a mortgage lender that allows you to put 3% down

You may be able to find a conventional loan with less stringent mortgage requirements, such as a 3% down payment. These mortgages are designed for low-income homebuyers who cannot afford a bigger down payment, and they can also be combined with down payment assistance programs.

Keep in mind that you’ll have to pay private mortgage insurance (PMI) on most home loans with a down payment of less than 20%.

 

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