Should you opt for a mortgage or personal loan? Find out what makes a difference when you’re buying a home.
Buying a house is a huge financial decision. When you’re ready to get prequalified, you might start to wonder whether you should look past a traditional mortgage or alternative home financing. Sorting through mortgages and personal loans may not be part of the American dream, but it’s crucial when you want to buy a home.
How do personal loans differ from mortgages?
Mortgages are specialized lending for real estate. When you take out a mortgage, you’re taking out a secured loan that uses the property you’re buying as collateral. The most common type of mortgage are fixed-rate 15- and 30-year terms. You’ll also come across interest-only mortgages and payment-option ARMs, but these are more complex and could lead to financial trouble if you’re not careful.
An alternative financing tool for your home purchase is a personal loan. You’ll generally need good or excellent credit for a personal loan, but you’ll still be able to find lenders that specialize in loans for those with less-than-perfect credit.
Personal loans are generally unsecured so you won’t have to put up any collateral. The result is that you pay more in interest and have a shorter term, generally less than 10 years. Personal loans aren’t usually intended to fund a home purchase, but that doesn’t mean it isn’t possible. As long as your lender agrees to your loan purpose, you can use your loan funds to finance property.
Main differences between personal loans and mortgages
|Interest rate||Varies by lender, usually between 3.99% to 36%||Varies by lender, but can start as low as 3.2% for a fixed-rate mortgage|
|Maximum loan amount||Up to $100,000, depending on the lender and your eligibility||High-cost area limit goes up to $954,225 for a single unit|
|Loan term||Typically between 1 to 7 years||Typically 15 or 30 years, but can be as short as 10 years or as long as 50 years|
|Repayment frequency||Usually monthly repayments||Usually monthly repayments|
Compare personal loans from top online lenders
What are the benefits of personal loans and mortgages?
- No tax implications. >You won’t be charged unless the debt is forgiven by the lender.
- No down payment needed. Unlike mortgages, many lenders don’t require you to provide any cash up front in order to qualify for a personal loan.
- Negotiate repayments. You may be able to negotiate your repayments if you’re facing financial hardship or an emergency.
- Secured. Because the loan is secured with your property, lenders are more likely to offer a low APR.
- Prequalification. You can get prequalified and go house shopping with a clear picture of what you’ll be paying every month.
- Tax advantages. You can deduct your interest, mortgage points and your real estate taxes from your yearly income tax calculations.
What are the drawbacks of personal loans and mortgages?
- Short repayment terms. Most lenders have repayment terms lasting one to seven years.
- High interest rates. Since you’re not providing collateral, you’ll likely have a higher interest rate and will need to pay more in interest over the life of your loan.
- Small loan amounts. You’ll only be able to borrow $100,000 if you have impeccable credit. Otherwise, your funding will be limited.
- Foreclosure. If you fail to make payments and default on your mortgage, you may face forclosure and lose your home.
- Amount paid. Despite low interest rates, mortgage loan amounts tend to be very large. This means that by the end of your repayment period, you’ll likely have paid tens of thousands of dollars in interest alone.
- Payment fluctuations. With an ARM, the payments you make can fluctuate drastically depending on the market.
Which borrowing option is better suited for me?
The better option will depend on your needs as a borrower. Mortgages are by far the most common option because they’re meant for real estate. Fixed rates make for an easy repayment plan, even if it doesn’t have as attractive an initial interest rate as an ARM. If rates drop significantly, you can take steps to refinance a fixed-rate mortgage, which can lower your monthly payment.
In addition, buying a home outright on $100,000 or less is nearly impossible in most parts of the country. Some lenders will allow you to use a personal loan as a down payment, but otherwise, you’ll have a hard time covering the costs of a purchase. However, if you’re looking to fill that new home with some furniture, a personal loan is an option to consider. Personal loans can be used for many purposes, which make them useful when it comes to home improvements or other big purchases.
Using a personal loan as a down paymentYou generally won’t be able to use a personal loan as a down payment. Lenders will ask for proof that you have the funds available to pay yourself. However, if you have no existing debt, some lenders may allow you to use a personal loan and consider it in your debt-to-income ratio when considering your application.
If you can’t afford a down payment and won’t be able to use a personal loan, there may be a first-time home buyer program available in your state to help you afford the down payment.
What’s the difference between a personal loan or a remortgage?
You might have come across the term remortgage in your research. A remortgage is another term for refinancing. When you remortgage or refinance your mortgage, you pay off your current mortgage with a second mortgage through a new lender, usually one offering a lower interest rate or better terms.
While refinancing can sound complicated, it’s common practice for people who have improved their credit over time or live in areas with high real estate fluctuation. If your home’s value has increased or you’ve simply found a lender offering a better deal than your current mortgage, you may be able to save thousands of dollars in interest over the long term while reducing your monthly payments.
The refinancing or remortgaging process is more similar to taking out a mortgage than borrowing money with a personal loan. If you’re happy with your current mortgage but need a loan for home improvements or other big expenses, you might want to consider a home equity loan or line of credit instead. These options are like personal loans, except your repayment period is spread out over 15 to 30 years, rather than a personal loan’s average 1 to 7. A home equity loan is also secured against your house, meaning the interest rates can be lower that a personal loan’s.
When choosing between a remortgage and a personal loan, the better option depends entirely on what you need the loan to do. A remortgage is ideal for specific goals — like lowering the monthly payments on your house or switching from an ARM to a fixed-rate mortgage — while a personal loan is designed to cover costly purchases without restrictions. Approval for both usually depends on a decent credit score and a history of timely payments.
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Personal loans can be good for a wide variety of things, but they’re not necessarily the best for funding the purchase of a home. Mortgages are exclusively used for purchasing real estate and can generally offer you better terms. Before you make any big financial commitments, you should talk with a financial advisor and compare your options. Whichever you choose, have your finances in order and understand the full impact of each type of loan when you apply.