Often, the most challenging part of buying a home is coming up with a down payment. Whether your lender is allowing 3% down or youre hoping to hit 20% to reduce your monthly payments and avoid mortgage insurance, saving up all that cash isnt easy for most people. With the national average home price currently hovering around $270,000, according to Zillow, a 20% down payment would require you to save up about $54,000.
Thats quite a sum, and even the lowest possible down payment may feel out of reach for cash-strapped homebuyers. Using a personal loan to cover some or all of your down payment may sound like a great solution, but it wont fly with most mortgage lenders. Heres what you need to know about using a personal loan as a down payment—plus some alternatives that may be worth exploring.
Buying your first home is an exciting milestone! But saving up enough cash for a down payment can be a major obstacle, especially for first-time buyers. If your savings account is lacking, you may be tempted to take out a personal loan to cover the down payment on your dream home.
While it may seem like a quick fix, using a personal loan for a mortgage down payment comes with some big risks and limitations. In this comprehensive guide, we’ll explain everything you need to know about tapping personal loans for down payments, including
- When personal loans can and can’t be used for down payments
- The pros and cons of using a personal loan for a down payment
- Alternatives to pay for your down payment without a personal loan
- Tips for saving for a down payment and improving your homebuying eligibility
Let’s dive in!
When Can You Use a Personal Loan for a Down Payment?
In general, most mortgage lenders frown upon borrowers using personal loans to fund down payments There are a few key reasons why
- It increases your debt-to-income ratio (DTI), which lenders view as more risky
- It suggests you don’t have the savings for a down payment, raising questions about your reliability
- Personal loans have higher interest rates, making them more expensive than a mortgage
However, there are some cases where a personal loan may be allowed:
- Certain adjustable-rate mortgages or portfolio loans from smaller lenders
- If you have an excellent credit score and low DTI even with the personal loan
- When paired with a larger down payment from your own savings
But exceptions are rare, so proceed with caution if you plan to depend on a personal loan.
The Pros and Cons of Using a Personal Loan for a Down Payment
Before committing to a personal loan for your down payment, weigh these potential advantages and drawbacks:
Pros
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Fast funding: Personal loans can provide lump sums quickly, which helps if you have a short homebuying timeline.
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Flexible uses: You have leeway to use the loan for any purpose, not just a mortgage.
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No collateral required: Personal loans are unsecured, so you don’t risk losing an asset.
Cons
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Higher rates: Even excellent credit scores may only qualify you for a 9-15% APR on a personal loan.
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Impact on DTI: Lenders prefer your DTI stay below 36%. A personal loan could tip you over.
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Mortgage eligibility: Most conventional, FHA, and USDA loans don’t allow personal loan down payments.
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Tough approval: Lenders may deny those without robust finances and long credit histories.
As you can see, the drawbacks typically outweigh the upsides of funding a down payment with a personal loan. Keep reading for better options!
Alternatives to Personal Loans for Down Payments
Luckily, you have many other avenues to cover your down payment without taking on expensive personal loan debt:
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Save aggressively: Make a budget to increase your monthly savings rate. Consider a side hustle too.
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Down payment assistance programs: Nonprofits and government agencies offer grants if your income is below a certain level.
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Gift or loan from family: Receiving gift funds from relatives is allowed with a gift letter. Be sure to disclose any loans.
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401k loan: You can borrow up to 50% of your vested 401k balance without tax penalties.
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Low down payment mortgage: Options like VA and USDA loans allow 0% down for qualified applicants.
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Sell assets: Bank your profits from liquidating stocks, bonds, or other non-retirement investments.
With creativity and commitment, you can amass a down payment without saddleing yourself with costly personal loan debt!
Tips for Saving for a Down Payment
If you have some time before buying, diligently saving is the safest way to afford a down payment. Here are tips:
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Make a monthly budget to find areas to cut back on discretionary spending. Sites like Mint can help track spending.
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Set up automatic transfers from each paycheck to a high-yield savings account. Online banks offer up to 2% APY.
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Look for clever ways to slash monthly costs like buying generic brands, cutting the cable cord, or refinancing debt.
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Consider taking on a side gig like dog walking, rideshare driving, or freelance work to earn extra cash.
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Live below your means. Get a roommate, downgrade vehicles, or consider more affordable housing.
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Avoid unnecessary debt like credit cards, personal loans, and car leases which eat into your homebuying fund.
With consistent savings over time, you can amass enough cash to make a solid down payment and achieve homeownership.
Improving Your Mortgage Eligibility
In addition to saving for a sufficient down payment, you can improve your chances of mortgage approval by:
- Paying down debts to lower your DTI ratio below 36%
- Checking your credit reports to dispute any errors dragging down your scores
- Avoiding new credit applications in the months preceding your mortgage application
- Gathering essential documents like tax returns, pay stubs, and bank statements to verify income and assets
- Shopping around with multiple lenders to find the best rates and loan options
Meeting standard eligibility criteria through good financial habits will make you a very attractive mortgage applicant in lenders’ eyes.
Frequently Asked Questions About Personal Loan Down Payments
If you’re still weighing whether to use a personal loan for your down payment, consider these commonly asked questions:
How much do you need for a down payment?
Down payment requirements vary by loan type, but you can expect to put 3-20% down. Conventional loans start around 3-5% down. FHA is 3.5%, and VA/USDA are 0%.
What credit score is needed for a personal loan?
Most lenders require a 660-720 FICO score or higher to qualify for a personal loan. Those with scores below 600 will have a very hard time getting approved.
How does a personal loan affect your credit?
The hard inquiry when applying can cause a small ding, but making on-time payments builds positive credit history. Overall impact depends on the rest of your credit profile.
Can I get approved for a mortgage if I have a personal loan?
Yes, but since the personal loan raises your DTI, you’ll need a strong credit score, low debt, and substantial assets to demonstrate you can manage both monthly payments.
What are the most affordable ways to pay for a down payment?
The cheapest options are saving up over time, qualifying for down payment assistance, borrowing from retirement accounts, or applying for low/no down payment mortgage programs.
The Bottom Line
While personal loans provide fast access to lump sums, the risks and limitations make them a less-than-ideal way to fund a mortgage down payment. You’re better off exploring alternatives to avoid piling on expensive debt before buying a home. But with strategic saving, budgeting, and shopping around for the right mortgage, you can position yourself for smooth sailing through the homebuying process.
Frequency of entities from given sources:
personal loan – 20
down payment – 20
mortgage – 10
lender – 5
credit score – 5
debt-to-income ratio – 4
Explore Loans That Require a Lower Down Payment
FHA loans, which are geared to first-time homebuyers and insured by the Federal Housing Administration, approve eligible borrowers with as little as 3.5% down. There are other federally backed loans worth exploring as well. USDA loans, which are geared toward certain rural and suburban homebuyers, require no down payment at all. The same goes for VA loans, designed specifically for U.S. service members and their surviving spouses; you also wont have to pay mortgage insurance on these loans.
Hold Off Until You Can Save More
Slowing down and taking some time to increase your savings could be all it takes to get approved for a mortgage. This begins with creating a realistic budget and making a spending plan that allows you to funnel extra income toward your down payment. Cash windfalls such as tax refunds, raises and work bonuses can also help you save more money with little effort.
Youll also want to use this time to improve your credit as much as possible before applying for a mortgage. Borrowers who have strong credit and steady income may qualify for a conventional loan with only 3% down.