Using a Personal Loan for a Down Payment

According to statistics, personal homeownership in America stands at around 65.8%, which, to be frank, is an impressive rate by all accounts.

However, these kinds of figures don’t paint the actual picture.

Questions like how many of these homeowners had to take out a personal loan for a down payment aren’t answered yet. They are some of the most critical concerns.

When it comes to owning homes, how you finance the down payment and the purchase itself is quite literally as important as owning the actual home.

Getting the necessary financing to purchase a home isn’t the biggest problem for most people. The real issue lies in paying the down payment that comes with owning that house.

So, should you take out a personal loan for a down payment?

If so, how can you get the best deals?

If not, what are your options?

Should You Take Out a Personal Loan for a Down Payment?

No, you shouldn’t use a personal loan to cover your down payment when purchasing a house.

That answer, however, isn’t that simplistic. There are a lot of factors that go into formulating the right answer for you as an individual.

That being said, most mortgage lenders typically don’t entertain the idea of borrowers taking out a personal loan to make a down payment on their potential house.

Why Shouldn’t You Use a Personal Loan for Down Payment?

Many different loan types, including an FHA loan and other conventional loans, don’t typically allow home buyers to take out personal loans and use that as down payments for mortgage lending.

That, however, doesn’t mean that you can’t find a lender that does, but even if you do, it doesn’t mean that you should take out a personal loan for this huge expense. Again, there’s a very good reason for this:

According to credit rating bureaus such as Experian, before most lenders give you any money, especially huge sums of money such as that involved in mortgage lending, they do a deep dive into your financial background.

There’s something called the debt-to-income ratio (DTI), which is a gauge of how your current debts relate to your declared income.

This means that these credit rating bureaus will take a much closer look at things like your pay stubs and any other legal businesses or sources of income that you have.

They will also pull your current credit report to determine how much of your declared earnings go into servicing your outstanding debt. This comes down to looking at everything you owe and all your monthly repayment amounts.

That means your:

And yes, personal loans as well.

Should they find that your debt-to-income ratio (DTI) is higher than 43%, which is the standard percentage required by most lenders, they will either deny your loan or give it to you at a much higher interest rate and more stringent terms.

Any DTI higher than 43% is considered a highly risky loan.

If you take out a big personal loan for the single purpose of making a down payment, your DTI will be pushed higher by that loan, and that is a big red flag for most lenders.

There are cases where a simple personal loan nudges your DTI over the eligibility threshold, which means that you wouldn’t qualify for the specific loans you would like.

Sometimes, it also suggests to potential lenders that you aren’t in the best position to buy a home.

Technically, this will disqualify you as an eligible mortgage borrower and drive down your credit score, putting you in dire straits as far as your borrowing options are concerned.

What Can You Use as a Down Payment Instead of a Personal Loan?

Granted, the down payment is one of the most expensive aspects of buying a home. Unfortunately, it’s also one of the biggest deterrents and a path most homeowners must take.

What are your alternatives when it comes to paying your down payment?

What can you use instead of a personal loan to make a down payment on your new house?

Don’t Buy a Home Just Yet

In many, if not all, cases, lenders want to see that the borrower has some money saved up and can comfortably pay back what they owe. This often means they will look into your bank accounts to see if you have any savings.

Since most realtors and mortgage lenders require you to put down a least 3% of the entire house price as a down payment, the best approach is to save more money before applying for a mortgage.

This may mean holding off a little before you can buy that house. However, some advantages come with this:

  • You will get the time to look for the right kind of house
  • Lenders will be more inclined to give you a mortgage at an affordable rate

You may surpass the customary 3% down payment and make a larger deposit, which brings you closer to outrightly owning the house and means that you have to borrow way less from your mortgage lender.

This process typically calls for having a strict budget and doing frugal things such as channeling your tax refunds towards your overall down payment.

You may also want to try and improve your credit score by reducing your overall debt or increasing your revenue streams.

That way, when the time comes for you to borrow money, lenders will give you more favorable rates. It also means that you will have access to much better loans, some which offer you the conventional 3% down payment option.

Open house

Look for Loans that Don’t Require a Huge Down Payment Sum

Depending on your eligibility, there are many federally backed loans that you could check out. Most of these loans not only give you excellent terms and rates but also offer you the chance to pay a much smaller down payment if any at all.

For example, an FHA loan, typically backed by the Federal Housing Administration, is an excellent option for first-time homebuyers looking to borrow money to buy a home. These loans require eligible applicants to pay a 3.5% down payment on that home purchase.

Other options, such as USDA loans, are offered to certain suburban and rural homebuyers. USDA Loans typically don’t require any down payment at all.

Another excellent option that hardly ever requires a down payment is a VA loan designed to help veterans and active-duty servicemen and women get homes.

The best part about the VA loan is that you are not only not required to pay a down payment but also won’t be required to pay the customary mortgage insurance when dealing with these loan funds.

Look for Suitable Down Payment Assistance Programs

Some programs, such as the National Homebuyers Fund, are designed to ease the burden of buying a home for eligible individuals.

Such programs often offer grants that can be used to make the down payment on a house.

These grants range in size but are typically around the 5% down payment mark. The easiest way to get around this is to visit the U.S. Department of Housing and Urban Development (HUD) and search through the many available down payment assistance programs by state.

4. Borrow from Friends or Family

If you are lucky enough to have family members or friends who are financially well off, then borrowing from one of them would be a better idea than taking out a personal loan.

But, of course, these kinds of arrangements are very sensitive and should only be taken up when both of you are comfortable with the arrangement.

While this might not be a formal personal loan, you must develop a viable repayment plan.

This helps you achieve two things:

  • Pay your lender back regularly until the loan is complete
  • Show mortgage lenders that there is repayment in place

You might wonder why you must show mortgage lenders that you are paying back money borrowed from a friend or family member. T

hat’s mostly because most lenders want you to substantiate the source of any large deposits into your account. Once you have explained that away and shown them the agreed-upon repayment plan, those figures will factor into your debt-to-income ratio (DTI).

So what if the money isn’t borrowed but rather a gift?

In this case, whoever gifted you the money would have to provide the lender with a signed gift letter indicating that the money isn’t borrowed and doesn’t need to be repaid.

This way, your debt-to-income ratio (DTI) remains intact.

Sell-Off an Asset

You might consider selling off portions of your portfolio if you have any valuable assets, such as land or shares in a business. Granted, this isn’t the best of ideas since you will need the security that comes with having assets.

However, if they are assets that can earn you the money you need to make the down payment without taking out a personal loan, selling them off would be worth considering.

The idea is to try as much as possible not to use a personal loan for a down payment. The main reason for that is because the moment you inquire about taking out a personal loan, that inquiry is recorded on your credit history, and that negatively affects your credit rating, albeit temporarily.

That temporary dip in credit rating could either disqualify you from some of the best mortgage options available or make you a high-risk borrower.  You will be offered higher rates and a stricter loan term.

Refraining from making any hard inquiries or taking on additional debt during this mortgage application period is key to keeping your credit rating intact.

Related Resources: