For many homebuyers, saving up for a down payment for a house can be quite a chore. That may lead you to ask, “Can I use a personal loan for a down payment on a house?”
Unfortunately, the answer is generally no. Most mortgages prohibit the use of personal loans for a house down payment. But even if your lender does allow it, it’s unlikely to be your best bet anyway.
Why you can’t use a personal loan as a down payment
Fannie Mae and Freddie Mac are two government-sponsored entities that back many conventional mortgages. However, they do not permit the use of a personal loan to buy a house.
The reason is simple: taking out a mortgage means taking on new debt. Using a personal loan for closing costs or a down payment means you will have to take out one form of debt just to pay another.
Additionally, during the home buying process, lenders will dive into your finances to verify your income as well as your debt-to-income ratio. Your DTI compares the percentage of your gross income that is eaten by debt payments.
If your DTI is above 43% – or 36% in some cases – it suggests that you are a risky borrower who could default on a loan. Since personal loans are debts, taking one out to cover your down payment will increase your DTI, which could disqualify you from a mortgage altogether.
Alternatives to a personal loan for a down payment
Even if your lender does accept personal loans for a house down payment, making a move like this is not financially wise. Why stack two big loan payments on top of each other? Instead of digging yourself into a deeper hole, consider these alternatives.
Wait until you can save more
Spending a few years saving up for a down payment isn’t the quickest way to buy a house. Still, the more you save, the less you will need to borrow. Set up a firm budget and allocate extra cash, like tax refunds or work bonuses, towards your house-related savings account. You can also use this time to boost your credit score, which can help you qualify for better interest rates.
Look into down payment assistance programs
Government and nonprofit down payment assistance programs help lower- and moderate-income homebuyers get into a home. These programs offer grants or second mortgages up to about 5% of a home’s purchase price.
The U.S. Department of Housing and Urban Development website allows prospective homebuyers to search for local programs by state.
Consider FHA loans, USDA loans or VA loans
FHA, USDA and VA loans are government-backed loans that help different types of homebuyers afford a house.
- FHA loans require 3.5% down and a credit score of 580 or greater. While the FHA doesn’t set income limits, these loans require borrowers to pay private mortgage insurance (PMI).
- USDA loans require 0% down, but these loans are only eligible on homes within select rural or suburban zones. Additionally, homebuyers must pay 1% upfront and a fee of 0.35% per year.
- VA loans are available to military service members. They require 0% down, and while they do require an upfront funding fee, this fee, as well as other closing costs, can be rolled into the mortgage.
Seek out 3% down payment mortgage programs
Some lenders offer conventional loans with less strict requirements for lower-income buyers, including 3% down payments. Better yet, you can use down payment assistance programs to cover the costs, getting you into a home faster.
Aside from FHA or USDA loans, you can look into programs like HomeReady or Home Possible, both of which require just 3% down. Just keep in mind that eligibility limits may apply.
That said, most lenders require borrowers to pay PMI for mortgages with less than 20% down. And since you’ll be taking on more debt, your monthly payment and long-term interest may increase. Still, for many borrowers, it beats taking out a personal loan for a down payment on a house.
Withdraw from a retirement account
Instead of using a personal loan to buy a house, another option is to withdraw money from your retirement fund. Some retirement accounts, like 401(k)s and IRAs, allow you to borrow from your balance for a down payment without counting against your DTI.
However, these withdrawals come with limitations, and if you don’t repay yourself, you’ll have to pay taxes as well as penalties. Plus, you’ll be borrowing from your future and possibly losing growth by pulling money from your investments.
Borrow from family
If you have a family that is willing to help, you might want to approach them and ask for down payment assistance. That said, you’ll want to treat this arrangement very seriously to avoid ruining your relationship.
For starters, consider crafting a written contract that details how you will repay them. Report this personal loan for a house honestly to your lender as well. If they gift you the funds, your lender might require a signed gift letter to legitimize the transaction.
Finding options when purchasing a home
Personal loans are useful for making large, necessary purchases, consolidating debts, or paying off urgent bills. However, most lenders forbid using personal loans for closing costs, a down payment or other parts of the mortgage process. Even if they didn’t, using one loan to pay off another doesn’t work in your favor in the long run anyway.
Do you really need a 20% down payment for a house?
You’re not required to put 20% down on a house. But if you don’t put 20% down, you’ll likely end up having to pay private mortgage insurance, which increases the cost of your loan.
Will getting a personal loan affect my credit?
Obtaining a personal loan can impact your credit in a few ways. For instance, your score may drop when you take out the loan or if you miss a payment. But if you make all of your payments on time, your credit score can rise and benefit you in the long run.
What are the minimum down payment requirements?
Different mortgage programs set different down payment requirements. For instance, VA and USDA loans don’t require any down payments. Meanwhile, many conventional mortgages require anywhere from 3% to 20% upfront.