Using a Personal Loan for a Home Down Payment

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What is an unsecured loan?

An unsecured loan is issued mostly on a borrower’s creditworthiness, as opposed to a secured loan, which requires some form of collateral, such as a home, vehicle or savings account. Unsecured loans include most personal loans and student loans, while common examples of secured loans include mortgages and car loans. You don’t necessarily need a high credit score to qualify for an unsecured loan, but borrowers who have the highest credit ratings generally get the best interest rates and terms.

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Is an unsecured loan right for you?

Depending on your financial needs, personal assets and credit history, an unsecured loan might be the right option for you. Unsecured loans involve borrowing money without having to put up the collateral needed for a secured loan. The advantage of a no-collateral loan is that you avoid the risk of repossession if you don’t make loan payments.

As you might expect, unsecured loans are considerably riskier for lenders, especially for borrowers with subpar credit. Such borrowers can expect to pay higher — and in some cases much higher — interest rates. Still, lenders will most likely consider other factors as well, such as your income and debt-to-income ratio, or how much debt you have relative to income.

The terms on unsecured loans have typical lengths of two to five years, while the total loan amounts often range from $1,000 to $50,000. Unsecured loans can also be used for almost anything — for business loans, home improvement projects and covering medical bills, as well as for consolidating debt (popular with personal loans) and even paying for big-ticket purchases, such as a major vacation.

Who should consider an unsecured personal loan?

Consumers who need money quickly might want to consider an unsecured personal loan. This is because the application and approval process tends to be fast, sometimes taking just a few hours. Access to funds is typically quick, too, often within a matter of days following loan approval.

Personal loan proceeds can be used to pay for almost anything, including the following:

  • Business expenses
  • Home improvement projects
  • Debt consolidation
  • Credit card refinancing
  • Vehicle purchases
  • Medical expenses
  • Moving expenses
  • Vacations
  • Wedding expenses
  • The approval process is quick: With unsecured loans, you may be able to access your funds within a day or two of being approved.
  • Unsecured loans aren’t backed by collateral: Unlike secured loans, unsecured loans don’t require collateral as backup. For example, a mortgage requires a home as collateral and an auto loan requires a vehicle for the same reason. If you default on an unsecured loan, nothing will be repossessed.
  • Rates are fixed. Unlike other forms of credit, such as credit cards, which have variable interest rates, unsecured personal loans usually have fixed interest rates. This means your monthly payments will be consistent and predictable.
  • Unsecured loans can be discharged in bankruptcy: If you experience an unexpected financial disaster — and earn no more than your state’s median income — you may be able to discharge the debt on an unsecured loan if you need to file for Chapter 7 bankruptcy. After bankruptcy, you might also be able to use an unsecured loan to help rebuild your credit.

Can you get a personal loan for a home down payment?

By Hannah Rounds

Most of the time, you cannot use a personal loan for a down payment on a house. Conventional and FHA mortgages prohibit the use of personal loans as a source for down payments. Even if you can find a lender that will allow you to use a personal loan, it is unlikely to be the best option for a down payment. A personal loan is an unsecured loan — meaning it’s not backed by any particular asset — that borrowers repay in equal installments over a set period of time. Unsecured loan lengths typically last between 24 to 72 months, but sometimes longer.

5 reasons why a personal loan may be a bad option

  1. You don’t need 20% down to buy a house. Competitive interest rates are available for buyers who can put as little as 3.5% down on a house.
  2. It could lower your credit score. You want your credit to be in top form when applying for a mortgage, but applying for credit or taking out a new personal loan can lower your credit score — at least initially.
  3. It limits loan options. Using a personal loan for a down payment disqualifies you from taking out an FHA or a conventional loan.
  4. Homeownership is expensive. Adding a personal loan payment to a new mortgage payment may leave you feeling tight on cash. It can be tough to handle a personal loan payment on top of a new mortgage, property taxes and regular home maintenance costs.
  5. Interest rates on personal loans can be high. Even the lowest average personal loan interest rate for borrowers with excellent scores (10.30%) is nearly 7 percentage points higher than current interest rates on 30-year mortgages (at time of writing).

If you can use and want a personal loan for your home down payment…

If you’re interested in pursuing a personal loan and you find a mortgage lender who will allow you to use one, it’s important to get the best deal on the loan. Compare monthly payments, interest rates, terms and fees from at least three lenders to be sure the loan makes sense for you.

Compare lenders according to factors like …

  1. Range of APRs: Shop around to find the lowest annual percentage rate (APR) on a personal loan. The APR is the total cost of borrowing money when fees are included.
  2. Origination fee: Some lenders have no origination fees, but others charge upfront fees up to 6% of the loan balance — and in some instances, even higher.
  3. Minimum credit requirements: Some lenders have strict credit score requirements for borrowers, while others are more lenient. In general, the higher your credit score, the more competitive your interest rate could be.
  4. Repayment periods: Most personal loans have payoff periods ranging from 24 to 72 months, but some lenders offer shorter or longer loans. Longer loans offer lower payments, but your total interest charges will be much higher.
  5. Monthly payments: Since you’ll pay the personal loan payment along with a new mortgage, it’s important to keep your monthly payment reasonable.
  6. Autopay discounts: To get the best rates, some lenders require borrowers to set up their loans on autopay.
  7. Prepayment penalties. Many personal loans don’t have prepayment penalties, but it is best to avoid lenders that charge you extra for paying off your debt.

Why your home down payment matters

Before 2007, most homeowners put down 20% when buying a home. Today, half of all buyers put down 6% or less, and at least one in 10 buyers put 0% down on a house.

While mortgages with low down payments or 0% down are popular, a robust down payment can be helpful for your bottom line. When you save up a down payment and you have good credit, you’ll qualify for a better interest rate. Plus, the more money you put down and the better your credit score, the lower your monthly payment will be.

Nevertheless, many lenders offer competitive interest rates to buyers with lower down payments. Depending on income and other factors, you could qualify for a conventional loan with as little as 3% to 5% down.

7 other ways to obtain a down payment for a mortgage

In general, financial windfalls are tough to come by. But every April, many Americans can expect to get a big influx of cash to their bank accounts, thanks to the income tax refund. In 2019, the average refund was $2,869. Save this windfall and you’ll jump start your down payment savings fund.

Serious savers can set up an automated transfer between checking and savings that corresponds with their paycheck. Transfer $200 to savings with every bi-weekly paycheck, and you’ll have $15,000 in the bank within three years — that’s enough for a 5% down payment on a $300,000 house.

It’s possible you may qualify for a down payment assistance program. These government or nonprofit programs aim to help those with low or moderate incomes buy their first home. Generally, these programs offer grants or second mortgages that can help you buy a home without a huge down payment.

If you’ve been saving for retirement, but not for a home purchase, a 401(k) loan could make sense. A 401(k) loan is an arrangement where you borrow money from your own vested retirement balance. Over time, you’ll pay yourself back with interest.

The Good Neighbor Next Door program offers up to 50% off a house for firefighters, teachers, law enforcement officers and emergency medical technicians who want to buy a house in a revitalization area. The U.S. Department of Housing and Urban Development (HUD) designed the program to bring professionals who can contribute to community revitalization to selected areas of the country. To qualify for the program, you must live in the house for at least 36 months.

Most lenders see a gift from a family member as an acceptable source of funds for a down payment.

The IRS allows qualified first-time homebuyers to use up to $10,000 from an individual retirement account (IRA) without paying a penalty when the money goes towards a home purchase. Although you avoid the penalty, you still have to pay income tax on the $10,000 you withdraw from the account.

Explore alternative mortgage options if you don’t have much for a down payment

FHA loan

FHA loans are best known as first-time homebuyer loans. However, these loans, which only require a 3.5% down payment, offer excellent terms for anyone struggling to save up a large down payment. They are also a great option for borrowers who have less than perfect credit, as the FHA loan allows a 3.5% down payment for borrowers with credit scores as low as 580.

VA loans

A VA mortgage is a benefit for military service members in the United States, including members of the National Guard and reservists. It allows borrowers to take out a mortgage with a 0% down payment. The loan’s upfront funding fee adds up to 3.3% to the cost of the principal balance of the mortgage, but the funding fee and other closing costs can be added to the mortgage. In general, interest rates on VA mortgages are competitive with rates on conventional mortgages. That makes the VA loan an appealing option for service members and veterans who may not have enough money for a large down payment.

USDA loans

USDA loans are zero down home loans for people living in rural areas. To qualify, you must earn less than 115% of your area’s median income, and be the primary occupant of the house. These mortgages come with a modest 1% upfront fee, and a 0.35% annual fee.

3% down mortgage programs

Home Possible® and HomeReady® mortgages are conventional mortgages that are designed for low income homebuyers who cannot afford a bigger down payment, as each program allows borrowers to buy a house with as little as 3% down. These mortgages can also be combined with down payment assistance programs.