According to the National Association of Realtors, the down payment is the biggest barrier to homeownership for consumers. Saving money while paying monthly rent is a huge challenge for many homebuyers, especially first-timers. Fortunately, you might speed up the process by borrowing some or all of your mortgage down payment.
Can You Borrow Your Down Payment to Buy a Home?
In general, mortgage lenders will let you borrow a down payment — but the usual acceptable ways — 401(k) loans or purchase money second mortgages — have some real disadvantages.
Borrowing from your 401(k) is okay with mortgage lenders because you’re borrowing from yourself. That can be extremely risky, however. If you change employers, your company goes out of business, or you’re laid off, you have to pay that loan back in 60 days or face steep taxes and penalties.
In addition to taxes at your normal tax rate, you also face a 10% penalty. If your tax bracket is 25%, you end up taking a 35% hit on your remaining balance. And that’s in addition to your state income taxes.
Purchase money second mortgages, or “piggyback” loans, come in several guises. They get their names from the percentage of the purchase price they provide and the amount that you’ll cover. For instance, an 80/10/10 loan is an 80% first mortgage, a 10% second mortgage, and a 10% down payment. An 80/15/5 loan covers a 15% down payment and requires 5% down from you, and an 80/20 loan needs no down payment at all. However, these loans have become nearly impossible to find.
You can also try for government-backed home loans if you’re eligible for VA or USDA financing. FHA loans require just 3.5% down but their mortgage insurance is very expensive. Fannie Mae has a 97% loan, but it comes with mortgage insurance as well as surcharges of up to 3.75% ($3,750 for every $100,000 borrowed).
Personal Loans for Home Down Payments
Ask loan officers or underwriters if you’re allowed to borrow your down payment with a personal loan and they will probably say no.
But that’s not the whole story — you can buy a home with a personal loan. There’s a point at which borrowed funds become, for all practical purposes, your own money. They need to be on deposit, aka “seasoned,” for at least 60 days (preferably 90 days), and lenders will consider the money yours.
For example, if you take out a $50,000 personal loan and deposit it into your checking account, it gets mixed with your other cash (“co-mingled”). Three months later, you apply for a mortgage. The lender won’t ask you to specify which funds in your checking are from the loan. It’s all yours.
This can help you qualify for a home loan because you have a bigger down payment as well as “reserves,” which are funds available after closing to pay your mortgage. Reserves are expressed in months — the number of mortgage payments you can cover with savings if you have an interruption of income. If your mortgage payment is $1,000 and you’ll have $6,000 after closing, you have six months of reserves.
However, you will have to disclose your personal loan balance and monthly payment. It will probably show up on your credit report and the lender will incorporate the personal loan payment into your qualifying ratios.
What Personal Loans Are Available for Mortgage Down Payments?
If you want to use a personal loan to buy a home, you have a few considerations:
- How long do you want to take to repay your loan?
- What is your current credit rating?
- Do you need a co-signer or co-borrower?
- Do you want a secured or unsecured loan?
Work through these factors before shopping for a personal loan.
Loan term
The loan term impacts your repayment in two ways: longer terms lower your payment while shortening your term gives you lower interest rates. The chart below shows how the combination of length and rates affects your monthly payment (and your debt-to-income ratio, or DTI) with LightStream, a national lender specializing in applicants with good-to-excellent credit.
Personal Loan Terms & Payments for Excellent Credit With a Loan Amount of $25,000
Credit rating
Your credit rating has the biggest impact on your interest rate because most personal loans are unsecured. The credit score needed to get a personal loan varies depending on the company. The lender’s only guarantee of your repayment is your promise to do so. So they look very hard at your previous experience with debt — did you always pay on time?
For instance, highly-rated Best Egg offers $50,000 loans with three-to-five year terms at rates (APRs) ranging from 4.99% for applicants with stellar credit to 29.99% for those with poor credit scores. You can see how adding points to your credit score can significantly reduce what you pay for personal loans.
Cosigners and co-borrowers
Cosigners can help you get approved for loans if your credit is a bit shaky. A co-signer is responsible for repaying your loan if you fail to make your payments as agreed. Don’t ask someone to co-sign for you unless you are very committed to repaying it and certain that your job is secure. Understand that your co-signer is doing you a HUGE favor and taking a very large risk.
Co-borrowers can help if your debt-to-income ratio is on the high side. Co-borrowers are jointly responsible for the loan payments with you. Even if they don’t receive any of the loan proceeds. Understand that if you miss a payment or pay late, it shows up on your co-borrower’s credit report and can clip up to 100 points from their credit score.
Your co-borrower or cosigner might even want to make the payments directly to the lender while collecting the same amount monthly from you to protect his or her credit score.
Co-borrowers and cosigners can also help you get a better interest rate.
Your rate will depend on several factors:
- The cosigner or co-borrower’s credit score
- Both of your credit histories
- Your combined debt-to-income ratio
- The lender’s underwriting policies
Underwriting policies and interest rates vary widely, so it’s smart to compare several lenders.
Secured vs. unsecured personal loan
While most personal loans are unsecured, it can make sense to borrow with a secured loan. Secured personal loans offer lower interest rates because there is less risk to the lender. If you can’t repay your loan as agreed, your lender could sell your property to get money to repay your loan balance.
If borrowing for a home down payment, you should avoid securing your loan with your new home. Your mortgage lender will likely deny your loan application if you have no equity. Instead, borrow against other assets like a car or boat or art. That way, the personal loan is separated from your home purchase.
Secured loans can take longer to get because the lender has to evaluate the asset value.
Finding the Best Personal Loan to Buy a Home
Expect to shop a bit to get the best personal loan for a home purchase.
Understand that, unlike mortgage shopping, every personal loan application generates a separate inquiry on your credit report, and each inquiry trims three to five points from your credit scores. So you’ll want to limit your applications to companies that specialize in serving borrowers like you — with similar credit profiles and offering the loan amount and terms you desire.
Because most personal loan providers require you to prequalify or apply before disclosing the rate they’re willing to offer, you might want to start with companies that prequalify you without making a “hard” credit inquiry. Instead, these companies use other metrics to estimate your credit score. You will eventually have to authorize a credit pull and complete an application once you decide on a lender.
