Taking out a personal loan to cover a mortgage down payment can help some people afford their dream home.
A lower loan-to-value (LTV) ratio can help buyers avoid mortgage insurance and improve their housing expense ratio. PMI makes housing less affordable.
On the other hand, adding a new installment contract pushes up the back-end debt-to-income (DTI) ratio. This percentage tells bankers the price of the house you can afford.
Unsecured personal loans can also reduce the risk of losing the property in a foreclosure. Periodic bouts of a disability, unemployment, or the death of a spouse can happen to anyone.
Review the pros and cons of using a personal loan for a home deposit across four areas.
Down Payment Personal Loan Pros & Cons
Taking out a personal loan for a down payment on a house has distinct advantages and disadvantages.
- On the plus side, it protects homeowners during periods of financial distress and improves the front-end debt-to-income ratio (DTI).
- On the negative side, it hurts the back-end DTI, and the principal amounts can be too small to matter.
Start a personal loan request here if this option works best for you unique situation. People with high credit scores and strong income are most likely to qualify. Begin early as the underwriter may require that you season the funds for at least 60 days. The new account should appear on your consumer report by that time.
Taking out an unsecured personal loan to cover a down payment on a house can offer greater safety. The chances of keeping your place of residence are much better in the event of financial hardship. These are the three biggest triggers that cause people to fall behind on payments – risking foreclosure.
- Death of spouse
The borrower’s signature supports the unsecured obligation rather than any collateral. Therefore, the lender cannot seize the property in the event of default. In addition, debt settlement programs can reduce the amounts owed for unsecured, but not secured obligations.
However, the bank can file suit and attach a lien against your property. The lien activates only when and if you sell the home. Meanwhile, you still have a place to live.
Using a personal loan to fund a mortgage deposit improves the buyer’s front-end debt-to-income (DTI) ratio. This housing expense percentage is an important qualifier. The ideal limit is 28% of gross monthly income. The calculation has four components.
- Mortgage payment
- Mortgage insurance premiums
- Real estate taxes
- Homeowners insurance
Both the monthly payment and insurance premiums are lower when the LTV is smaller. Read more about the impact on the insurance premiums in the next major section.
Taking out a personal loan to fund a home down payment hurts the back-end debt-to-income (DTI) ratio. This combined monthly expense percentage is a second important qualifier. The ideal limit is 36% of gross monthly income. The calculation can include some of these components.
- Housing expenses noted above
- Student loans
- Credit card minimum payments
- Automobile leases and loans
- Child support obligations
Personal loans will inflate this percentage more than alternative approaches might. Unsecured obligations have higher interest rates and shorter repayment terms. These two factors combine to yield higher monthly payments than other sources of funding.
Size of Down Payment
A personal loan may not be big enough to make a meaningful contribution towards a home down payment. Only the most credentialed borrowers qualify for the largest amount a lender might approve – $35,000. Most people are eligible for much smaller amounts.
Conventional mortgages offer the lowest interest rates but require an LTV of 80% or less. This means a deposit of at least 20%. Consider these amounts based on home price. The average purchase price is approximately $188,000.
|Home Price||20% Deposit|
Clearly, a personal loan cannot finance the entire deposit requirement for most people. However, it could make a big difference if a buyer needed just a little more money to reach the magical 20% figure.
Using a personal loan to finance mortgage closing costs follows a similar thought process. Any borrowed amount will affect both sets of DTI ratios and the new trade will impact your consumer report and score.
However, closing costs are much smaller than a deposit (approximately 2% of principal vs 20%). Therefore, people are more likely to qualify for the required amount. Homebuyers falling just short of saving enough cash for both may find this option sensible.
- Lender-charged Origination Fees
- Commitment fee
- Document preparation
- Tax service
- Third-party Charges
- Attorney settlement
- Credit report
- Flood certification
- State and local transfer taxes
- Mortgage taxes
Avoid Private Mortgage Insurance With Loans
Using personal loans for a down payment on a house can help buyers avoid costly mortgage insurance premiums. The extra coverage allows individuals to qualify for a home with a loan-to-value (LTV) ratio above 80%.
These additional policies reimburse the lender in the case of default. Mortgage insurance does not cover the borrower for the three common calamities causing financial distress.
- Death of spouse
Both the Federal Government and private industry issue mortgage insurance and charge premiums. We use this configuration to present an apples-to-apples cost comparison for each option.
- $300,000 principal amount
- 0% interest rate
- 30-year repayment term
Public Mortgage Insurance
At least two federal government agencies offer mortgage insurance to the public needing to make smaller down payments. These programs target people with poorer qualifications. Therefore, the premium costs are much higher.
The Federal Housing Authority (FHA) program is popular with first-time buyers who lack the capital for a large upfront deposit. The down payment minimum is 10% for people with poor credit scores and goes as low as 3.5% for individuals with good credit scores.
FHA mortgage insurance premiums have two components.
- Upfront premium is 1.75% of the original principal
- Annual premiums vary by term and LTV
Borrowers with an LTV above 90% cannot cancel the coverage until they sell or refinance. Those with an LTV below 90% can escape the annual fees after 11 years of payments.
|5% Down||10% Down|
The United States Department of Agriculture (USDA) helps people afford homes in rural areas. Borrowers can finance a home through this agency with no down payment at all. The upfront premium is 2.0% of the original principle.
- $6,000 estimated cost for this option
USDA mortgages are very cost effective for the relatively few people willing to live in the boondocks. However, the majority looking to purchase a residence near a metropolitan area cannot take advantage.
Private Mortgage Insurance
Private mortgage insurance (PMI) allows individuals to finance a home purchase with an LTV above 80% (80% LTV). PMI rates range from .5% to 1% annually applied against the original principal amount.
Borrowers can cancel PMI when their LTV reaches 78%. It takes 136 monthly payments (11.3 years) on our example mortgage to reach this threshold.
- $33,900 total costs at the 1% rate
- $16,950 total costs at the .5% rate
Other Loan Types for Mortgage Down Payment
A personal loan is not the only way to borrow money for a mortgage down payment. The most common options are tapping into the resources of your extended family, siphoning funds from a retirement account, and a piggyback loan.
Each of these options has a dark side should the homebuyer encounter financial hardship. Remember the three common mishaps.
- Death of spouse
Borrow From Family
Borrowing money from family members for a mortgage down payment is not always a smart move. If your parents or siblings have the financial means to offer a gift, they would. Apparently, they need you to repay the funds.
Mortgage lenders will examine your bank accounts looking for large deposits. The underwriters will treat loans from family members as they would any other disinterested third party. Therefore, there is no advantage.
However, there is one big drawback. Defaulting on a loan to your parents, brother, sister, aunt, or uncle could sink the entire family. Bad things can and do happen. Keep your family out of trouble.
Borrowing money from a 401k is another option to cover a mortgage down payment. The forced savings of an automatic payroll deduction is the only way many people can save money. Review the pros and cons before taking this step.
Tapping a 401K or other retirement saving programs does not several advantages.
- Not reported to the credit bureaus
- No negative impact on credit score
- Does not affect DTI ratios
The downside of a 401K rears its ugly head after a bout with disability or unemployment. Many people lose their jobs after a disability. Legal job protections end after only 12 weeks – if covered by FMLA.
Separation from an employer converts the 401K loan into a hardship withdrawal. You must pay interest and penalties during a time of financial distress. In addition, your retirement savings just went up in smoke.
Piggy Back Loans
A piggyback loan is another name for an 80-10-10 mortgage. With a piggyback program, the buyer puts down a 10% deposit. Then a second lender funds the remaining 10% using a Home Equity Line of Credit (HELOC).
The HELOC is a secured revolving account that features a draw period of 5 to 10 years and a repayment term of 10 to 20 years. The borrower has the flexibility to make interest-only payments during the draw period.
The primary advantages of the 80-10-10 approach are three-fold.
- Smaller monthly payments because of the longer term
- Does not affect front-end DTI
- Impacts back-end DTI
- Lower interest rates because the property secures the note
- Tax-deductible interest charges
The biggest drawback to the piggyback option comes when a borrower loses the house in default.
- Interest only payments cause the balance to grow quickly
- Buyers can fall behind on the much large payments once reaching the repayment stage
- Lenders often take possession of the property after default
- The buyer has no place to live, little income, and few options
Down Payment Assistance Grants or Personal Loans
Personal loans are sometimes a preferred option when compared to mortgage down payment assistance grants. With an assistance grant, the person does not have to repay the money.
So how could a loan be better than a grant? Eligibility and our old friend the prospect of financial hardship are two reasons.
- Grants target specific groups such as veterans, low-income households, teachers, firefighters etc. Many people just do not belong to a preferred group.
- Many down payment assistance programs come with strings attached. The person must live in the home for a minimum period. Somebody defaulting on payments could be on the hook for the loan and the grant. They may experience a double whammy when they can least afford it!
- Death of spouse
Two federal government agencies offer home buying assistance to several sets of target groups.
The Department of Veterans Affairs (VA) helps service members, veterans, and eligible surviving spouses become homeowners. Qualified veterans can obtain a home loan with as little as zero money down.
The VA insures the mortgage at no cost to the borrower. There is no minimum time to stay in the home. Thank you to the men and women who served our country in uniform.
Housing and Urban Development
The US Department of Housing and Urban Development (HUD) offers two worthwhile programs.
- The American Dream Down Payment Initiative provides grant funding to local housing agencies. The program has two main eligibility criteria.
- First-time homebuyers who have not owned a property in the last three years
- Household income does not exceed 80% of the area median income
- The Good Neighbor Next Door program helps grade school teachers, firefighters, emergency medical technicians, and law enforcement officers. Qualified buyers obtain a 50% discount off the list price of homes in urban revitalization areas. The person must occupy the property for 36 months as the sole residence.
State & County Government
State and county government agencies also offer down payment assistance grants. Some of these regional housing authorities administer the American Dream program. Others operate using local funding sources.
Below is a partial list. Research the available grants in your state and county to determine your eligibility.
- The Indiana Next Home program offers down payment assistance. Qualified Hoosiers can receive 3% towards FHA loans, and 4% towards conventional mortgages for help with their deposit. The aid can work like a grant. There are no interest charges or monthly payments. The Indiana Housing and Community Development Authority forgive the full amount when borrowers stay in their home for 2 years or more.
- The New Jersey Smart Start program provides zero-interest down payment assistance for up to 4% of the first mortgage amount. This aid also can become a grant. The New Jersey Housing and Mortgage Finance Agency forgive the balance for buyers who remain in the house after 5 years.
- The New York City HomeFirst program offers up to $25,000 in down payment assistance to first-time homebuyers in the five boroughs. The New York City Housing Preservation & Development Agency forgives the loan when people stay in the home 10 or 15 years as determined by income.
- The Suffolk County HOME Consortium provides a down payment assistance program to eligible first-time buyers in this Long Island County. The consortium forgives the conditional grant of up to $10,000 when the owners stay in the home more than 5 years.