Should You Get a Personal Loan Before Buying a House? Here’s What to Consider

Buying a house is an exciting milestone in life for many people. However, it also requires careful planning and financial preparation. One question that often comes up is whether you should take out a personal loan before buying a house.

There are some pros and cons to getting a personal loan first. On one hand, the funds from a personal loan could help cover costs leading up to buying a house. But on the other hand, taking on additional debt before applying for a mortgage could negatively impact your ability to qualify for the home loan.

In this article, we’ll explore both sides of this issue to help you make the best decision for your unique situation.

How Personal Loans Can Help with Homebuying Costs

Here are some of the ways the funds from a personal loan could assist with the home buying process

• Down payment assistance – Though most lenders discourage borrowing funds for a down payment, some may allow you to use a personal loan for this purpose in certain circumstances. Even a small loan of $5,000-$10,000 could make a difference between affording a 20% down payment or not.

• Closing costs – The closing costs on a home purchase often amount to 3-5% of the total loan amount. A personal loan could help cover these fees so you don’t have to drain your savings. Average closing costs range from $6,000-$12,000.

• Home repairs or renovations – Many buyers take on needed renovations soon after purchasing. A personal loan can fund essential repairs or cosmetic upgrades to make the home your own.

• Furniture and appliances – Furnishing an entire house gets expensive quickly. Appliances, furniture and window treatments can easily total $5,000 or more. A personal loan provides access to cash for these myriad homebuying expenses.

• Moving expenses – The costs involved with moving your belongings can add up fast. From hiring a moving company to renting a truck and buying boxes and supplies, movers often spend $1,000 or more. A personal loan offers an easy way to pay for these relocation expenses.

As you can see, a personal loan offers a convenient way to pay for many common costs leading up to and right after buying a home. This extra cash could make an enormous difference in being able to afford everything on your homebuying checklist.

How Personal Loans Can Hurt Your Mortgage Qualification

However, there are also some potential drawbacks to getting a personal loan before applying for a mortgage. Here are a few ways this debt could negatively impact your home loan application:

• Higher debt-to-income ratio – Mortgage lenders calculate your back-end DTI based on your total monthly debt payments divided by your gross monthly income. A personal loan payment increases this ratio, which could make qualifying more difficult.

• Lower credit scores – The hard inquiry and new account from a personal loan could cause a small temporary drop in your credit scores. Lower scores could lead to higher interest rates or denial.

• Shorter credit history – Most lenders prefer borrowers to have at least a 2-year history for each credit account. A new personal loan could fall short of this benchmark.

• Riskier loan profile – From the lender’s perspective, applicants with many new debts and credit inquiries may seem overextended or desperate for cash in the months leading up to their mortgage application.

• Lower loan amounts – Even if you’re approved, having additional monthly debt payments could mean you qualify for a lower mortgage loan amount than you need or desire.

As you can see, these potential consequences could seriously impact your ability to get approved for a home loan and buy the house you want. That’s why it’s so important to consider both sides before taking the leap with a personal loan.

Tips for Getting a Personal Loan Before Buying a House

If you decide to proceed with a personal loan first, here are some tips to mitigate the risks:

• Only borrow what you absolutely need so your loan payment stays low.
• Pay off the full balance as soon as possible. The shorter time you have the debt, the better.
• Make sure you can afford the new loan payment easily within your budget. Don’t overextend yourself.
• Only work with lenders that report loan payments to the credit bureaus so you can build your credit history.
• Consider using a credit-builder loan that requires the funds to be held in a savings account as collateral. You receive the money only after successfully making the payments.
• Make every payment on time! Set payment reminders and autopay to protect your credit.
• Limit applications for new credit before applying for a mortgage. Too many inquiries in a short timeframe raises red flags.
• Wait 12 to 18 months after getting the personal loan before applying for a home loan. This allows time for any credit score impacts to rebound.

Key Factors That Determine if You Should Get a Personal Loan First

As you weigh this decision, keep the following factors in mind:

• Your credit scores – The higher your starting scores, the less impact a new account will likely have. If your scores are marginal, a dip could spell trouble.

• Your DTI without the loan – If your back-end DTI is already close to 36% before adding a new payment, you probably can’t afford any additional debt.

• Your down payment savings – The more you can pay upfront, the lower your loan amount needs to be, which helps approval odds.

• Your job stability – Lengthy tenure at the same employer makes lenders more comfortable with new debts. Recent changes could cause hesitation.

• Your repayment term – For less impact, opt for the shortest term you can manage to get the loan paid off ASAP.

• Timeframe to apply for a mortgage – If you won’t be ready to buy for 2 years or more, short-term personal loan impacts will have time to resolve.

• Your comfort with risk – There’s always a chance your mortgage application gets denied after taking out a personal loan. Make sure you can live with that gamble.

Carefully weighing each of these elements can guide you toward the right decision given your unique financial situation and homebuying timeline.

Alternatives to Consider Before Getting a Personal Loan

Here are a few options that allow access to cash without all the same risks:

• 401(k) or retirement account loan – If available, these loans don’t impact your credit or DTI ratio in most cases. Just be sure to repay the loan before leaving your job.

• Cash-out mortgage refinance – Tapping equity in your current home circumvents the need for new credit accounts and inquiries.

• HELOC – Home equity lines of credit also use your existing home as collateral, so they don’t show up the same as other debts.

• Family loan – Borrowing informally from family members is another way to avoid credit impacts. Just be sure to document the terms properly.

• Credit card cash advance – Although not ideal, this may cause fewer issues compared to a personal loan if paid off quickly.

• Savings – The best option, if possible, is to save gradually so you have cash on hand before house hunting begins.

The Bottom Line

Ultimately, there are reasonable arguments on both sides of this issue. Getting a personal loan before buying a house could certainly help cover expenses, but also comes with the risk of complicating your mortgage application.

The best approach is to consider your unique situation carefully, run the numbers to understand potential impacts, and weigh your options thoroughly before making a decision either way. With proper planning, you can likely minimize any negative effects from a personal loan if you determine the benefits outweigh the risks.

Just remember, you never want to jeopardize your ability to get approved for the mortgage loan amount you need. Be sure to think your decision through beforehand and implement strategies to keep your finances in great shape as you navigate the homebuying process.