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Being able to afford the down payment on a mortgage is often the biggest struggle for first-time homebuyers. Lenders typically ask for 20% down on conventional mortgages or require you to purchase private mortgage insurance (PMI), which can be expensive.
A personal loan might seem like a good way to cover that high upfront cost, but it’s not always possible — or a good idea.
Can I use a personal loan for a down payment on a home loan?
You might be able use a personal loan for a down payment on a home loan in some cases, but it’s rare. While personal loan providers don’t prevent you from using your funds to pay for a down payment, most mortgage companies do.
In fact, many mortgage providers check all inquiries on your credit report over the past year to make sure you haven’t taken out a personal loan.
This is because taking on debt to pay off more debt could make it harder for you to afford your home loan. There’s a reason mortgage providers ask for a down payment — it means you’re financially stable enough to take on such a large amount of debt.
Disadvantages of using a personal loan
Even if your mortgage company allows you to use a personal loan to pay for your down payment, you might want to reconsider it. That’s because the drawbacks often outweigh the benefits.
It lowers your credit
Every time you apply for a loan, your lender pulls something called a hard credit check — also known as a hard credit inquiry. A hard inquiry shows up on your credit report and temporarily lowers your credit score.
Having a recent credit inquiry doesn’t look good when you apply for a loan. And with a lower credit score, you likely won’t qualify for competitive rates and terms.
It raises your debt-to-income ratio
In addition to lowering your credit score, taking on more debt means you have a higher debt-to-income (DTI) ratio. Your DTI is based on your monthly debt obligations and income. It’s also one of the top factors that lenders consider when you apply for a loan.
The higher your DTI, the less likely a lender will give you favorable rates or terms. Most mortgage companies won’t work with borrowers who have a DTI higher than 43%.
You’ll have more monthly payments
You’ll have less money to spend each month if you take out a personal loan to pay for your mortgage’s down payment.
If you’re unable to afford both payments, you risk ruining your personal credit score if you can’t pay off your personal loan. And if you can’t afford to pay off your loan and your mortgage, you could end up losing your home.
Is it ever a good idea?
A personal loan might help in some extreme situations if you have excellent credit and minimal monthly debt obligations. But double-check that your lender allows you to use a personal loan for the down payment before you apply.
You have money coming in, but need to make an offer now. You’re waiting for funds to come in from something you’re legally entitled to in the near future, like an inheritance. But you have an offer on your dream home right now that can’t wait. A personal loan may bridge the gap until you receive your funds.
You’re moving for a job — and not on a trial basis. You got a high-paying job with airtight security and buying a home makes more financial sense than paying the sky-high rent in your new town. You can easily pay off your personal loan quickly while comfortably affording your mortgage payments once you start working.
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5 alternative ways to pay for a down payment
Just because a personal loan might not be the best way to pay for a down payment doesn’t mean you don’t have other financing options. If you need help covering the upfront cost of your mortgage, you might want to check out one of these five alternatives.
1. A mortgage with a lower down payment
While conventional mortgages often come with a 20% down payment or more, that’s not the case with all mortgages.
FHA mortgages. Mortgages insured by the Federal Housing Administration (FHA) sometimes come with down payments as low as 3.5%. While you’ll be on the hook for mortgage insurance premiums (MIP), these may be less expensive than monthly personal loan repayments.
HomeReady mortgage program. Fannie Mae offers a mortgage program with down payments starting at 3%. To qualify, you have to take a homeownership education course, have a credit score of at least 620 and meet certain income requirements.
VA mortgages. One of the perks of being a veteran is that you might not need to make a down payment at all. Many loans guaranteed by the US Department of Veterans Affairs (VA) cover the full cost of your home and don’t require money up front.
USDA home loans. Residents of rural areas can apply for a home loan through the US Department of Agriculture (USDA). There are two options for USDA home loans: Guaranteed Home Loans and Direct Home Loans for low-income borrowers. Neither require a down payment.
2. Down payment assistance programs
Many states have down payment assistance (DPA) programs that offer grants you can use to cover the upfront costs of your home loan. To get started on your search, visit the US Department of Housing and Urban Development (HUD) for state grant programs and local nonprofits that could help.
3. Loans from friends or family
Borrowing from your friends or family can put your relationship at risk, but they’ll likely be more understanding if you hit a bump — and possibly willing to forgive the debt.
Not comfortable taking money from the people in your life? If you want to make it formal, you can draw up legally binding documents citing rates, terms and penalties if you’re unable to repay your loan on time.
4. 401(k) loans
If you have enough funds in your retirement account to cover your down payment and airtight job security, borrowing from your 401(k) could be a cheaper alternative to a personal loan. However, you run the risk of losing your retirement savings to heavy taxes and fines if not done right. You might want to check out our guide to 401(k) loans first to make sure you understand the risks and benefits.
5. Simultaneous second mortgage
Also known as a piggyback loan, simultaneous second mortgages are what they sound like: two home loans at once.
Typically, borrowers take out a first mortgage to cover 80% of the cost of their home. Then they make a down payment of 10% and borrow against that, taking out a second mortgage worth 10% of their home’s value.
While you won’t pay as little of a down payment as you would on an FHA loan, you’ll avoid having to take out mortgage insurance, which can be expensive.
Bottom line
Most mortgage lenders won’t allow you to use a personal loan to pay for the down payment on your home. And even if yours does, it’s not always the best idea. Instead, you might want to look into less risky, less expensive alternatives.
Can I use a personal loan for a down payment on a car?
Car loan providers are typically more flexible than mortgage lenders when it comes to using a personal loan for a down payment. Many allow you to use a personal loan to cover the down payment on a new car as long as you can prove that you’re able to afford both your car loan and personal loan repayments.
Do I need to make a down payment on a personal loan?
Usually no. Most personal loans are unsecured, meaning that you don’t need to put up collateral. But even those that require collateral don’t typically require a down payment unless it’s a loan for buying a specific product. For example, many vehicle loans require a down payment of around 10% to 20%.
What is the HOPE program?
The Homeownership and Opportunity for People Everywhere (HOPE) program is available through HUD and offers grants to low-income individuals and families who want to buy a home. HOPE recipients can use their grants to cover many different homeownership-related expenses, including down payments, renovations and legal fees.
Anna Serio is a lead editor at Finder, specializing in consumer and business financing. A trusted lending expert and former certified commercial loan officer, Anna's written and edited more than 1,000 articles on Finder to help Americans strengthen their financial literacy. Her expertise and analysis on personal, student, business and car loans has been featured in publications like Business Insider, CNBC and Nasdaq, and has appeared on NBC and KADN. Anna holds an MA in Middle Eastern studies from the American University of Beirut and a BA in Creative Writing from Macaulay Honors College at Hunter College, CUNY.
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