A house is one of the most significant purchases most of us will ever make. There are two main options for financing that purchase: pay cash or apply for a mortgage loan. Since very few of us can write a check for the price of a home, that leaves a mortgage as the only practical option for most home purchases.
But what about a personal loan? Personal loans can generally be used for any legal purpose. Could you use one to buy a house?
In theory, yes. In practice, a mortgage will almost always be a better option.
Let’s explore why that is the case.
Personal Loan vs. Mortgage
There are significant differences between personal loans and mortgage loans, and those differences affect the usefulness of these loans for buying a home.
1. Different Loan Types
A mortgage is a secured loan. Your home serves as collateral for the loan. If you don’t pay, the lender can foreclose, seize the property, and sell it.
Most personal loans are unsecured. There is no collateral. If you don’t pay, the lender has little recourse beyond selling the account to a collection agency.
2. Differences in Cost
Because personal loans are unsecured, they carry more risk to the lender than a mortgage would. Lenders respond by raising their interest rates.
The average US mortgage rate in January 2023 is 6.42%. The average personal loan rate is 10.16%. That makes a personal loan much more expensive.
3. Different Loan Sizes
Most mortgage lenders won’t lend less than $100,000. The upper limit is much higher. Super jumbo mortgages can run up to $25 million if you have the income and credit score to support it.
Personal loans are much smaller. Many lenders cap personal loans at $50,000, and very few will lend more than $100,000.
4. Different Loan Terms
Most mortgages have 30-year terms, allowing affordable monthly payments. Personal loan terms typically run from three to five years.
5. Different Closing Processes
One advantage that personal loans have over mortgages is a much faster and simpler closing process. Many personal loans offer near-immediate approval and release of funds within one business day.
A mortgage requires a complex closing process that can take days or weeks and incur closing costs in the thousands of dollars.
6. Different Down Payments
Most mortgages require a substantial down payment. A personal loan does not require a down payment.
7. Different Risks
If you do not repay your personal loans, you will have problems with collection agencies, but there will be no bank ready to seize your property,
It’s not as scary as not making mortgage payments. If you default on your mortgage, your home may be foreclosed.
Can You Use a Personal Loan to Buy a Home?
Realistically, probably not, and even if you could, you probably wouldn’t want to. Here’s why.
- You can’t borrow enough. The median US home price (Q1 2022) is $428,000. Most personal loan lenders won’t lend more than $100,000.
- It’s too expensive. Interest rates for personal loans are much higher than interest rates for mortgages.
- No special deals. The Federal Housing Administration (FHA), the Veteran’s Administration (VA), the Department of Agriculture (DA) and many state agencies offer programs to make mortgages more affordable. No such programs exist for personal loans.
A mortgage is a specific tool designed for a specific purpose: financing a home purchase. It’s almost always the best tool for that purpose.
The exception to the rule would be a case where you are buying something that mortgage lenders won’t finance. Many mortgage lenders will not finance mobile homes or manufactured homes. Some tiny homes may carry prices below the lending threshold of many mortgage lenders.
If you’re purchasing one of these residences, a personal loan may be your best choice.
Using a Personal Loan to Buy Land
Buying a piece of land can sometimes be a great investment. For instance, you could buy a piece of land and use it to build a home in a situation where you cannot find your dream house. Yes, you can use a personal loan to buy land.
Lenders are often quick to approve and finance personal loans, sometimes even on the same day you apply. You can choose this way to buy land if you need to move fast or if you want to avoid a cumbersome underwriting and appraisal process and the costs of closing a mortgage or traditional land loan.
Some personal loan lenders specify whether their loans may be used to purchase land. But you will want to ensure that your personal loan lender permits you to utilize loan funds for a land purchase. Every lender has its own regulations for qualifying.
Can You Use a Personal Loan To Finance a Down Payment?
Your lender won’t accept a down payment from a personal loan. For example, If you purchase a standard home and need a conventional mortgage, your down payment may range between 3% and 20%, depending on the lender and the situation. You can’t take out a loan for that amount and still qualify for the mortgage.
Personal loans increase your debt-to-income ratio (DTI), making it harder for you to receive mortgage approval.
Lenders will know if you try to use a personal loan to cover your downpayment. They have access to your credit reports and other financial information.
Which One Should I Use?
A mortgage is the best way to go to buy a conventional home unless you have the capacity to pay cash. Consider a personal loan for tiny houses, mobile homes, and manufactured homes.