Considering whether to borrow money for a down payment on a new home? You have options, which include taking out a home equity loan or home equity line of credit (HELOC), or even asking a friend or relative for a private loan.
Below, you’ll learn the pros and cons of the various ways you can borrow money for your down payment, so you make the right decision for your financial needs.
Buying a house is an exciting milestone in life. However saving up enough money for a down payment can be challenging for many people. If you don’t have enough savings getting a loan for your down payment may be a good option. In this complete guide, we’ll explore everything you need to know about getting a loan to cover your down payment when purchasing a home.
Why Getting a Loan for a Down Payment Makes Sense
There are several reasons why getting a loan for your down payment can be a smart move:
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Allows you to buy sooner. Without enough cash savings, you may need to delay your home purchase. A down payment loan lets you buy right away.
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Avoids heavy savings burden For many, saving 20% of the home value for a down payment isn’t feasible A loan removes this savings burden.
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Lets you hold onto cash. Some may have money in other accounts they don’t want to liquidate. A loan allows this.
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Spreads out costs. Rather than a huge one-time cash outlay costs are spread into manageable monthly payments.
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Can access better rates/terms. Some programs offer attractive rates and long repayment terms, making payments comfortable.
Generally, a down payment loan makes the most sense if you’re committed to homeownership but don’t have enough current savings to cover the down payment while still retaining a proper cash emergency fund.
Down Payment Loan Options to Consider
There are several options for getting a loan to cover your home’s down payment:
Mortgage with Down Payment Assistance
One option is to apply for down payment assistance through mortgage lenders. Many government-sponsored programs like FHA, USDA, and VA offer down payment assistance in conjunction with their mortgage products. Local housing agencies also have down payment assistance programs. These programs offer grants, forgivable loans, or deferred loans to cover some or all of your required down payment through your mortgage.
Pros
- Down payment given as grant or very low cost loan
- Allows low down payment even with poor credit
Cons
- Limited availability based on location and eligibility
Home Equity Loan
If you’re an existing homeowner with equity, a home equity loan or line of credit can provide funds for a down payment on a new home. You’ll borrow against the equity in your current home to get cash to put toward the next home.
Pros
- Fast access to cash for down payment
- May get better rates than with unsecured loan
Cons
- Risk losing home if can’t repay
- Closing costs and fees
Cash-Out Mortgage Refinance
Similar to a home equity loan, current homeowners can do a cash-out refinance of their current mortgage. This involves refinancing into a larger loan and taking some equity out in cash. That cash can then fund the down payment.
Pros
- Allows you to tap equity without second loan
- May get better rate than home equity loan
Cons
- Closing costs for refi
- Extends your loan term
Unsecured Personal Loan
For those without home equity, an unsecured personal loan from a bank, credit union, or online lender is an option. You borrow a lump sum, receive the cash, and use it to cover your down payment and closing costs.
Pros
- Fast approval and funding
- Fixed rates and terms available
Cons
- Higher rates than home equity loan
- Large loans may get denied
401(k) or Retirement Account Loan
Some tap their existing retirement savings via a 401(k) loan or IRA/401(k) withdrawal. This avoids taking on new debt but drains your retirement funds.
Pros
- Simple process with no credit check
- Low interest rate usually
Cons
- Lost retirement growth on borrowed funds
- Payback terms can be short
Family Loan
Asking a family member for a down payment loan is common. This can be an interest-free or low-interest option. Draw up a proper loan contract detailing terms and have it notarized.
Pros
- No credit check or income verification
- Flexible terms and low or no interest
Cons
- Could strain personal relationships
- No guarantees they’ll have funds to loan
As you can see, each down payment loan option has its own pros, cons, eligibility requirements, and costs. Be sure to explore multiple options to find the right loan product for your situation.
Factors to Consider When Getting a Down Payment Loan
If you decide to get a loan for your down payment, here are some key factors to consider:
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Interest rate and fees: Lower rates and fees make the loan more affordable. Compare options.
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Loan term: Longer terms spread out costs but increase total interest paid.
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LTV limits: Some loans limit the combined mortgage+down payment loan to 80% LTV.
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Recourse vs non-recourse: Recourse loans allow debt collectors to go after assets if defaulted. Non-recourse limits collections to the home. Know the difference.
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Repayment requirements: Understand if repayment of down payment loan is required right away or can be deferred.
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Qualifications: Each program has credit score, income, and other eligibility requirements. Review these carefully.
Doing your research is crucial to get a down payment loan that best fits your financial situation both now and in the coming years.
How Much Can You Borrow for a Down Payment?
Loan amounts for down payments can range quite a bit:
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Mortgage down payment assistance programs often provide 3-5% of the purchase price.
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Home equity loans allow you to borrow up to 85% of your available equity, sometimes more. With 20% equity, you could get up to a 17% down payment.
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Personal loans range from $1,000 to $100,000. Larger loans become harder to qualify for.
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401(k) loans are capped at $50,000 or 50% of your vested balance, whichever is less.
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With family loans, the amount depends on what the family member is willing and able to provide.
In most cases, you don’t want to borrow more than you are required to put down in order to qualify for the mortgage. Aim for the minimum while keeping monthly costs reasonable.
Pitfalls and Risks of Down Payment Loans
While down payment loans allow many to buy sooner, there are some potential pitfalls to be aware of:
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Less equity and potential underwater status: With less down, you start with less equity and can end up underwater if prices drop.
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Higher monthly costs: The added loan payment increases housing costs each month.
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Difficulty qualifying for mortgage: Adding the down payment loan obligation can make debt ratios look worse.
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Potential foreclosure: If you lose your income source and can’t pay all the loans, foreclosure is possible.
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Credit damage if loan not repaid: Failure to repay a personal loan, 401(k) loan, or family loan can harm your credit.
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Less retirement savings: Loans against retirement accounts mean less money compounding for your eventual retirement.
Think critically about these risks before moving forward. Have a solid emergency fund and budget so you can handle the extra monthly payment. And work to aggressively repay the down payment loan.
Tips for Getting Approved
If you want the best shot at getting approved for a down payment loan, keep these tips in mind:
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Have a down payment loan lined up before making an offer, if possible.
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Shop multiple lenders to compare loan options. Rates and terms vary.
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Get pre-qualified for both the mortgage and down payment loan. This shows you can handle both payments.
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Improve your credit score before applying. Scores above 700 help.
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Lower your debt-to-income ratio. Lenders may deny you if too much of your income is going to debt payments.
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Be ready to explain the down payment loan to the mortgage lender. They’ll want to verify the details.
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Have funds in reserve for closing costs and moving expenses. You’ll need more cash beyond just the down payment.
With proper planning and preparation, using loan funds for your down payment can be a viable way to become a homeowner sooner. Evaluate your options carefully and choose loan products that fit your financial situation. This can help you achieve your dream of homeownership while keeping risks and costs manageable.
Take out a HELOC or home equity loan
If you currently own a home, you can convert your equity into cash with a HELOC or home equity loan and use it to buy a new home. This may come in handy if you find a great deal on a new home but haven’t sold your current home and need cash to make a larger down payment.
A HELOC is a revolving line of credit that works like a credit card. When you use a HELOC for a down payment, you can:
- Use as much (or as little) of the credit line as you need during the draw period, which usually lasts 10 years
- Pay the balance to zero and charge it again during the draw period
- Pay interest only on the amount you draw
One caveat: If for some reason you don’t pay off the credit line balance within the draw period, you’ll have to repay it in installments over a repayment period that typically lasts 20 years.
With a home equity loan, you’ll receive the entire loan balance in a lump sum and make monthly installment payments based on the rate and term you choose. Most home equity loan terms are five to 15 years.
THINGS YOU SHOULD KNOW
If you’d prefer not to leverage the equity in your current home, you might want to consider an 80-10-10 loan for your new mortgage. You can borrow a first mortgage of 80% and then a home equity loan or HELOC for another 10%, leaving you with just a 10% down payment. When your home sells, you can pay off the home equity loan or HELOC and end up with just one mortgage payment.
Tap your retirement savings
Your retirement savings should never be used to bankroll big-ticket purchases. However, if your path to the golden years includes homeownership, you may want to use some of your savings to purchase a home.
If you have a 401(k), you may be able to take out a 401(k) loan for your down payment. You pay back the loan over time, and can typically borrow up to 50% of your account balance or $50,000, whichever is less, according to the IRS. Check with your financial planner or accountant before taking a loan or distribution.
What’s the Best Way to Save for a Mortgage Downpayment?
How do I get a down payment loan?
Asking a friend or family member for a down payment loan is another option. Lenders will only accept a private mortgage secured by an asset, which means you’ll need to put up your home, car or another valuable — like artwork — as collateral for the loan. Plan to document the following if you choose this borrowing path:
Can I borrow money to make a down payment?
Borrow 80% with a first mortgage and use a home equity loan or HELOC for the remaining 10%, leaving you with just a 10% down payment.When your home sells, you can pay off the home equity loan or HELOC,
How do you write a down payment for a home loan?
If you’re getting a conventional mortgage loan, for example, your down payment might be as little as 3 percent of the home’s price. Input your maximum down payment. This is the highest amount of money you’re willing and able to put toward your home purchase. Input the home’s purchase price. Input the loan term in months.
How do you use a down payment to buy a house?
To use it: Input your minimum down payment. This is the lowest amount of money you’re able to put toward your home purchase. If you’re getting a conventional mortgage loan, for example, your down payment might be as little as 3 percent of the home’s price. Input your maximum down payment.