Using a Personal Loan for a Down Payment

Saving up for a down payment on a home can be a challenging endeavor, which is why it can be tempting to take out a personal loan to use as a down payment. However, while personal loans can be used for many purposes, a mortgage down payment is not one of the recommended (or, in many cases, permitted) uses.

You may be rejected if you plan to use a personal loan as a down payment for a mortgage. This is because it may indicate you aren’t the most reliable borrower, as it can increase your debt-to-income (DTI) ratio. Understanding these restrictions can ensure you don’t breach any loan terms that could delay your approval for a mortgage.

Personal loans are sums of money that you can use for almost any purpose, originating from banks, credit unions and online lenders. Because of its versatility, it’s an attractive financial product.

Some uses for a personal loan include:

• To pay for large purchases: Paying for one-time large purchases, such as an appliance, furniture or similar, is the most common use of a personal loan. It allows you to get items or services that may otherwise take you a while to purchase and pay for them over time.
• To consolidate debt: If you have several debts, taking out a personal loan is a way to roll them into one large loan that’s easier to manage.
• To pay off high-interest debt: If you have a loan with a high interest rate, you can choose to refinance your personal loan to get a lower interest rate. But this only applies if you qualify and have a better credit score than you did before.
• To undergo a life change: Some life changes may require a big amount, such as starting a new career or paying for a wedding.
• To undertake a project: Financing a home renovation can be costly, which a personal loan can help pay for.
• To invest: While it’s risky and not recommended, some individuals use a personal loan to invest — for instance, investing in a friend’s business or purchasing loans or stocks.
• To pay for an emergency: Emergencies can crop up at any time, and sometimes, your emergency fund is not enough. This is where a personal loan can come in.

While it’s possible to use a personal loan as a down payment for a mortgage, it may be challenging.

Homebuyers are generally not allowed to use personal loans for down payments on conventional home loans and FHA loans. Personal loans are a form of debt. And the more debt you have, the riskier it is for the lender. Down payments are meant to reduce the risk on the lender’s end, which is why using a personal loan as a down payment for a mortgage is unlikely to work to your advantage.

But how will lenders know? Part of the typical mortgage approval process involves looking at your debt-to-income (DTI) ratio, which indicates how much debt you have compared to your income. Lenders generally require an average DTI ratio of less than 43% — and for some lenders, it's 36%. If you take out a personal loan to use as a down payment, your DTI will rise and potentially disqualify you from getting a mortgage.

On top of it being risky for the lender, juggling a personal loan and a mortgage can be taxing on your finances. Once you get your home, you're likely to pay for a host of other expenses, and ensuring your income is as "free" as possible to cover unexpected costs is vital.

On the off chance that you are able to use a personal loan as a down payment for a mortgage, understanding the pros and cons of doing so can help you determine if it’s the right path for you.

Taking out a personal loan to use as a down payment is not the wisest choice, as it can be a challenge to get and may cause more problems down the line. That said, there are other alternatives you can explore to ensure your homebuying experience goes smoothly.

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. Learn more about putting a down payment on a home and whether using a personal loan is a feasible option.