Using a Personal Loan for a Down Payment

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ByChristopher Boston
Reviewed byAlvin Yam, CFP
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ByChristopher Boston
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Reviewed byAlvin Yam, CFP
Edited byCasie McCoskey
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Updated: May 17, 2024

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Homeownership is often seen as the American dream, symbolizing stability and success. However, saving enough for a down payment can be challenging, leading some to consider using a personal loan. While this might seem like a quick solution, it's important to note that personal loans are generally not recommended or even allowed for this purpose.

Lenders view personal loans as additional debt, which could negatively impact your mortgage application. Understanding the restrictions around using a personal loan for a down payment is pertinent, as it could lead to the rejection of your mortgage application.

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What Is a Personal Loan?

A personal loan is a sum of money borrowed from financial institutions, including banks, credit unions and online lenders, that you typically pay back in monthly installments over a set period. Most personal loans are unsecured, meaning they don't require collateral, with fixed interest rates and repayment terms.

Personal loans can be used for various purposes, including:

  • Consolidating Debt: You can use a personal loan to consolidate multiple debts into one, offering a more straightforward way to manage payments and often reducing the overall interest rate.
  • Making Home Improvements: Borrowers often use personal loans to fund home renovations or repairs, which can enhance the value and comfort of their living space.
  • Covering Medical Expenses: Personal loans can provide a means to cover medical bills and health care costs that insurance coverage doesn't include.
  • Funding a Major Life Event: Many couples opt for personal loans to cover the costs of a major life event, such as a wedding or moving to a new place.
  • Financing Large Purchases: Personal loans are often utilized to finance major purchases, such as electronics or furniture, enabling individuals to acquire essential items without immediate full payment.
  • Covering Emergency Costs: A personal loan can serve as a financial safety net for unexpected expenses, such as urgent car repairs or sudden job loss, ensuring stability during unforeseen situations.
WHAT PERSONAL LOANS MIGHT NOT COVER

While personal loans are a versatile financial product, they are not meant to cover everything. Some expenses a personal loan might not cover include:

  • Educational Expenses: Personal loans for education vary in eligibility by lenders. You'll need to review the loan terms to see if you can use it for educational purposes. Federal or private student loans are often better funding options because they have more education-focused repayment terms.
  • Gambling or Illegal Activities: Personal loans often come with a clause to not use the funds for gambling or illegal activities. These are risky endeavors, which could mean the lender may lose their money if you cannot repay the loan.
  • Living Expenses: Using a personal loan to pay for living expenses isn’t prohibited, but it’s not the best idea if you’re strapped for cash. Instead, you may be able to find assistance programs and financial support for your utility bills and other everyday expenses.
  • Business Expenses: Some lenders may not allow you to use your personal loan to pay for business-related expenses. Instead, opt for a business loan, a business line of credit or a business card.

Using a Personal Loan for a Down Payment

While it may be possible to obtain a personal loan for a down payment, it is often a challenging and not recommended route. One of the primary reasons is that many mortgage lenders, especially those offering conventional home loans and FHA (Federal Housing Administration) loans, explicitly prohibit using personal loans for down payments.

Keep in mind that a down payment is viewed as an investment in the property, representing the borrower's commitment and financial stability. Using borrowed money for a down payment increases the risk for the lender, as it suggests the borrower might not have sufficient financial stability.

Taking out a personal loan for a down payment increases your debt-to-income (DTI) ratio, which measures the percentage of your income that goes toward paying debts. Mortgage lenders typically look for a DTI ratio of 43% or less. A higher DTI ratio signals a greater risk of loan default because it indicates that a larger share of the borrower's income is tied up in debt repayments. If adding a personal loan pushes your DTI ratio beyond this preferred threshold, it can make securing a mortgage more challenging.

When Mortgage Lenders Might Allow Personal Loans for a Down Payment

There are rare instances when mortgage lenders allow the use of a personal loan for a down payment. These exceptions typically depend on the borrower's future financial prospects and the assurance of incoming funds.

  • New Job With a Higher Salary: If you recently secured a job with a significantly higher salary, lenders may consider this as a mitigating factor. A higher wage can lower the debt-to-income ratio, making the additional loan for the down payment more manageable and less risky from the lender's perspective.
  • Proof That Money is Coming In: Lenders might be more lenient if you can provide verifiable evidence of incoming funds, such as an inheritance or a substantial bonus. This is because you can use these funds to pay down the personal loan used for the down payment, which reduces the financial risk and the impact on your overall debt levels.
HOW MUCH DO YOU NEED FOR A DOWN PAYMENT ON A HOUSE?

The amount needed for a down payment largely depends on the lender and the type of loan you're applying for. Conventional home loans typically require a minimum down payment ranging from 5% to 20% of the home's purchase price, with a higher down payment often eliminating the need for private mortgage insurance (PMI). FHA loans, which are popular among first-time buyers due to their more lenient credit requirements, typically require a minimum down payment of 3.5%.

Pros and Cons of Using a Personal Loan for a Down Payment

On the off chance that you’re able to use a personal loan for a down payment on a home, understanding the pros and cons will help you determine whether this option aligns with your current financial situation and future goals.

Pros of Using a Personal Loan for a Down Payment
  • It Can Expedite the Process of Getting a Mortgage: Using a personal loan for a down payment can speed up the process of securing a mortgage. It allows potential homeowners to provide the necessary down payment quickly, especially when they haven’t saved enough funds yet, leading to a faster homebuying process.
  • It Can Lower the Amount You Need to Borrow: By using a personal loan to increase the down payment, borrowers can reduce the principal amount they need to borrow for the mortgage. A larger down payment means borrowing less, which can result in lower monthly mortgage payments and potentially less interest over the life of the loan.
Cons of Using a Personal Loan for a Down Payment
  • It Can Strain Your Budget: Taking out a personal loan for a down payment can significantly strain your monthly budget. You'll be responsible for paying both the mortgage and the personal loan repayments simultaneously, which can lead to financial stress, especially if unexpected expenses arise.
  • It Can Affect Your Financial Opportunities: Using a personal loan for a down payment can impact your credit score and DTI ratio, potentially limiting your ability to qualify for other financial opportunities. This might include getting favorable rates on future loans or credit cards, as lenders may see you as a higher-risk borrower.
  • It Can Be More Expensive: Opting for a personal loan to cover a down payment can make the overall homebuying process more costly. Personal loans often come with higher interest rates than mortgages, increasing total expenditure over time when both loan costs are combined.

Weigh these benefits and downsides as you consider your options for a down payment on a home.

Factors to Consider Before Using a Personal Loan for a Down Payment

Before using a personal loan for a down payment on a home, consider the various factors that can affect your financial health and the success of your home purchase, including:

  • Impact on Mortgage Approval: A personal loan increases your overall debt, which can affect your mortgage application. Lenders assess your DTI ratio when evaluating your ability to repay the mortgage. A higher ratio due to an additional personal loan can make it harder to qualify for a mortgage or to get favorable terms.
  • Long-Term Financial Commitment: Taking a personal loan adds another layer of financial commitment on top of the mortgage. Consider if you can manage the additional monthly repayments without straining your budget. Factor in other financial responsibilities and potential future expenses to ensure you can comfortably meet all your obligations.
  • Interest Rates and Total Cost: Personal loans typically have higher interest rates than mortgages. This means the cost of borrowing for a down payment could be significantly higher over time. Calculate the total cost of the personal loan and the mortgage to understand the full financial impact and ensure it's a viable long-term strategy.
  • Limited Availability: Not all lenders allow the use of personal loans for down payments on mortgages. This limitation can restrict your options in terms of both lenders and mortgage products. It is important to research and confirm with potential lenders whether they accept personal loans for down payments.
  • Down Payment Size: The common misconception is that a 20% down payment is always required, but this is not the case for many mortgage types. While a larger down payment can reduce the need for PMI and potentially secure better mortgage terms, various loan programs offer lower down payment options. Before deciding on a personal loan, evaluate how much you really need for a down payment in relation to the type of mortgage you're considering. This will help you determine if taking on additional debt is necessary or if more suitable options are available.

The decision to use a personal loan for a down payment can have long-term implications on your finances, so evaluating these factors beforehand is prudent.

MONEYGEEK EXPERT TIP

Before you take out a personal loan, calculate the total cost and compare it to alternative financing options. To calculate the full cost of a personal loan, factor in the interest rate, loan term and any additional fees or charges. Use an online loan calculator to estimate the total repayment amount, including principal and interest. — Alvin Yam, CFP®

Alternatives to Using a Personal Loan for a Down Payment

Several options might offer more favorable conditions than using a personal loan for a down payment, potentially aligning better with your financial situation and long-term goals. These include:

  • Savings: Using your savings for the down payment is usually the most financially responsible option. It avoids the need for additional borrowing and interest payments and demonstrates financial stability to lenders. While saving up may take longer, it can lead to more favorable mortgage conditions and less financial stress.
  • Down Payment Assistance Programs: Various down payment assistance programs are available through state and local governments, as well as nonprofit organizations. These programs can offer grants or low-interest loans to help with the down payment, which is particularly beneficial for first-time buyers or those in specific income categories. These programs can significantly reduce the initial financial burden of purchasing a home.
  • Borrow From Family or Friends: Another option is to borrow money from family or friends. This can offer more flexible terms and potentially lower interest rates than conventional loans. Establishing clear terms will help prevent any strain on personal relationships.
  • Apply for a Loan That Requires Lower Down Payment: Certain types of loans, like FHA loans, VA loans (for veterans) or USDA loans (for rural properties), require a lower or no down payment. These loans can be a viable option for those who cannot afford a large down payment, though they might come with specific qualifications.

Exploring these alternatives to using a personal loan for a down payment can help ensure you make a financially sound decision when purchasing a home.

FAQ About Using a Personal Loan for a Down Payment

From making a bid to walking into your new home, purchasing a home is an exciting endeavor — but paying for a down payment is often the first major step. MoneyGeek answered some commonly asked questions to provide valuable insight on whether using a personal loan is feasible for your home's down payment.

What are the advantages of a down payment on a home?
What is the best way to put a down payment on a home?
What can you not use as a down payment?
Do banks check what you spend your loan on?
Do you have to say what you need a personal loan for?

About Christopher Boston


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Christopher (Croix) Boston was the Head of Loans content at MoneyGeek, with over five years of experience researching higher education, mortgage and personal loans.

Boston has a bachelor's degree from the Seattle Pacific University. They pride themselves in using their skills and experience to create quality content that helps people save and spend efficiently.


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