Personal loans have become an increasingly popular way of managing large expenses. A down payment on a house is one of the largest expenses many households will ever face.
Does that mean you can use a personal loan for a down payment on a house? Generally, no. Here’s an overview of personal loans and some alternative ways to afford your down payment.
What Is a Personal Loan?
Personal loans are a flexible, convenient type of financing that can be used for a wide variety of consumer expenses. While mortgages, auto loans, and student loans have to be used for their respective purposes, a personal loan can be used for almost anything. Popular uses include:
- Home renovations
- Debt consolidation
- Tax debt
- Wedding costs
- Unexpected/emergency expenses
Best of all, personal loans tend to offer relatively low interest rates, usually averaging around 9% to 10%. Compare that to the average credit card APR, which can be 20% to 22%, even for those with good credit.
Can You Use a Personal Loan for a Down Payment on House?
If personal loans are so flexible, can you use a personal loan for a down payment when you buy a home? Generally, no. While a personal loan might be used for loan programs not backed by Fannie Mae, you cannot use a personal loan for a conventional mortgage or an FHA loan.
Will borrowers know that your down payment comes from a personal loan? Absolutely — they’ll have access to your credit report.
Besides, using a personal loan for a down payment is simply unwise. Why? The average mortgage rate is around 6% — quite a bit lower than that of the average personal loan. It would actually make better financial sense to put down a smaller down payment and use your mortgage to cover the rest. Otherwise, you’ll be strapped with two monthly payments until your loan is paid off.
Do You Need a 20% Down Payment to Buy a House?
If you’ve considered using a personal loan for a down payment on a house, it may be because the traditional 20% down payment seems daunting. But you don’t always need to pay a full 20% down payment to buy a home. Some lenders even allow you to receive a conventional mortgage with as little as 3% down.
Some loan programs don’t require any down payment at all. These include:
- USDA loans (for homes in rural/suburban areas)
- VA loans (reserved for current/former military personnel and their spouses)
Loans backed by the Federal Housing Administration (FHA) are available even if your credit score is in the 500s. FHA loans require a 10% down payment, though if your credit score is 580 or higher, you can put down as little as 3.5%.
But when you put down less than 20%, you may be required to pay private mortgage insurance (PMI). This requirement doesn’t apply to USDA or VA loans, but other loan types will include PMI in your monthly mortgage payments.
Can You Take Out a Personal Loan for Closing Costs?
If you can’t use a personal loan for a down payment on a house, is it at least possible to use a personal loan for closing costs? You may have a bit more flexibility regarding these final costs, but most lenders will still prohibit you from doing so.
The reasons are the same as using a personal loan for a down payment. Even taking out a personal loan can signal to your lender that you lack the financial stability to make consistent payments. And once again, personal loans offer higher interest rates than most mortgages, meaning saving up is better to cover these costs.
Will a Personal Loan Affect My Credit?
What if you take out a personal loan to cover a different expense and free up money for a down payment? Will that impact your ability to secure a mortgage?
A personal loan can often reduce your chances of securing a mortgage, though in some cases, it may help you improve your financial circumstances.
Lowers Your Credit
Applying for credit or taking out a loan involves a hard inquiry on your credit report. That can potentially lower your credit score in the short term. If you fail to make on-time loan payments, it could damage your credit even further.
Depending on how far it drops, you may be disqualified from a particular loan program or be expected to pay a higher down payment. At the very least, you can expect a higher mortgage interest rate.
Reveals a Lack of Financial Stability
Lenders do not look favorably on those who have recently taken out a personal loan. Doing so can reveal a lack of financial stability, which creates risk for the lender.
Raises Your Debt-to-Income Ratio
Mortgage lenders look carefully at your debt-to-income ratio. The more debt you carry, the harder it will be for you to make your mortgage payments.
Adding to your total debt stock before applying for a mortgage is not a good idea. If you’re looking at buying a house, you want to be paying off debt, not adding more.
Can You Get a Loan for a Down Payment on a House?
Can you borrow money for a down payment without using a personal loan? Yes, though these options tend to be a bit more specialized. Here are some alternatives to a personal loan that you might consider.
Borrowing from Your Retirement Funds
If you have retirement savings, you may be able to tap into these funds to secure a down payment. You can always pay back your account over time.
Some retirement accounts make allowances for this. For example, a 401(k) loan allows you to borrow 50% of your account balance up to $50,000, which is enough to contribute to a down payment.
Borrowing from Friends or Family
Supportive friends or family can assist with a down payment. This can be a good option for first-time home buyers who need some help from their parents to complete their purchase.
Even with family, it’s wise to draw up some basic paperwork outlining the amount of the loan and an expected repayment schedule. Signing a promissory note can even make the loan legally binding and may be useful in providing lenders with information about the private loan.
A Home Equity Loan or Line of Credit (HELOC)
Do you already own a home? Then you may be able to tap into your home equity or open a line of credit for the down payment on your next house. A home equity loan provides a lump-sum payment equal to the equity left in your house, with options regarding your repayment terms.
A home equity line of credit (HELOC) works much the same way as a consumer credit card. You can borrow money up to a certain credit limit during the draw period (usually 10 years), though if you don’t repay the balance during this period, your repayment period can last up to 20 years.
Just make sure to compare rates and terms. These methods only make sense if your home equity loan or line of credit offers rates that are competitive with an actual mortgage.
A bridge loan is a highly specialized type of financing aimed at homeowners who have purchased a new home but haven’t sold their existing one. A bridge loan will provide you with more money than you currently owe on your existing home, which allows you to make a down payment on your next house.
Alternatively, you can use a bridge loan to take out a second mortgage, but this option is best for those with a favorable interest rate on their current mortgage.
Bottom Line: The Best Way to Make a Down Payment
While these loan options are helpful, the absolute best way to make a down payment is to save your money. Having enough for a down payment eliminates the need to search for loan programs or worry about taking on an additional monthly payment.
Down Payment Assistance Programs
You may qualify for down payment assistance (DPA) programs offered by your state or through a local bank. Check with your local housing agency for information about available programs. You may qualify for grants, discounts, or other forms of assistance, though you may have to meet certain requirements.
For example, if you work as a grade school teacher, firefighter, or emergency medical worker, you may qualify for the Good Neighbor Next Door program. Provided by the U.S. Department of Housing and Urban Development (HUD), this program allows you to buy a home at a 50% discount as long as you remain in the home for at least three years.
Other programs exist for nurses, law enforcement, and military veterans. As long as you adhere to the program requirements, you won’t have to pay back any assistance you receive, though check with each loan program for details.
Explore Your Options
The best way to make a down payment is to save. But even if you don’t have enough to cover a full 20%, you have options. Not every loan program requires a 20% down payment, and you can always find assistance through first-time buyer programs and alternative loan types.
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