Can You Use a Personal Loan for a Down Payment?

What does down payment mean?

A “down payment,” sometimes referred to as a deposit, is a lump sum of money a buyer pays up front in a financial transaction for an expensive good or service, such as a house or car. They can then fund the remainder of the cost of the house or car with a loan, such as a mortgage or auto loan. The lender and type of purchase will dictate the minimum down payment required. Some lenders may require down payments as low as 0% or as high as 50%.

The standard down payment on a home is 20%. However, there are programs in place that allow first-time home buyers to purchase a home with as little as 5% down. That said, the larger the down payment, the less the buyer will need to borrow to complete the transaction. Thus, larger down payments can reduce monthly loan payments and total interest paid.

How does a down payment work?

One of the most common instances where people make a down payments is for the purchase of a house. In this case, the person buying the house will pay a percentage, often 20% or 25%, of the total price of the house upfront. They’d then take out a mortgage to cover the remainder.

Check with the lender to understand the minimum down payment required, and know that you can put down more than the minimum if you choose. In some cases, you may come across a promotional offer for 0% down for buyers who qualify, which means no down payment is necessary.

Typically, the higher the down payment, the more likely it is that you’ll get approved for financing, and the better interest rate and terms you’re likely to receive.

Let’s take an example: if you’re buying a house for $200,000 and your lender requires a 20% down payment, you’d have to pay $40,000 up front. The mortgage would then be for $160,000. But if you pay more than the minimum, such as $60,000, your mortgage would only be $140,000. After making the down payment and securing the mortgage, you would then begin making monthly payments over the course of 15 or 30 years on the $160,000 or $140,000 loan amount plus interest.

Can you use a personal loan as a down payment?

Conventional and FHA loans do not allow homebuyers to use a personal loan as a down payment. Even if you can find a lender that allows you to use a personal loan to fund a down payment, it’s unlikely to be a good option. There are a couple of primary reasons for this:

When applying for a mortgage, the lender will pay close attention to your debt, recent pay stubs, and credit history to understand how much of your monthly income goes toward debt (or your debt-to-income ratio). Personal loans are included in this calculation. Most lenders require a DTI of less than 43%, though some lenders prefer 36% or lower. When you take out a personal loan, your DTI will increase, which could raise a red flag to lenders. In some cases, it may make you ineligible.

Having a high DTI and more outstanding debt can also lower your credit score, which will impact the interest rates and loan amount you qualify for.

Mortgage lenders want to ensure you have enough money in your bank account(s) to cover your down payment, which is also a good indication you can afford the monthly mortgage payments.

Plus, when you take out a personal loan for a down payment, you’ll have two loans you’ll be paying off, each accruing interest and potentially putting you further in debt.

If you’re struggling to come up with the money for a down payment, know that you don’t always need 20%. You may still be able to find competitive offers with lower down payment requirements, especially if you’re a first-time homebuyer.

Alternatives to a personal loan for a down payment

Although it isn’t a good idea to use a personal loan for a down payment, there are other options you can explore to afford it.

1.Other loans with lower down payments

You can look beyond traditional mortgage lenders to secure a mortgage with less money down. Examples include:

• FHA loans, specifically geared toward first-time homebuyers, are insured by the Federal Housing Administration and approve eligible borrowers with as little as 3.5% as a down payment.

• USDA loans are designed for certain rural and suburban homebuyers and require no down payment.

• VA loans are for U.S. service members and their surviving spouses and don’t require a down payment. You also won’t have to pay mortgage insurance on these loans.

2. Borrow from family and friends

If you have a friend or family member who is in a position and willing to lend you money for a down payment, this could be an available option. If you choose to borrow from friends or family, it’s important to agree on a repayment plan ahead of time to ensure a smooth experience.

Also, keep in mind that a large deposit in your account will need to be explained to lenders. If the money is a loan from a friend or family member, clarify the monthly payments you are responsible for to the lender as it factors into your DTI. If the money is a gift and doesn’t need to be repaid, the lender may require the giver to sign a gift letter.

3. Down payment assistance programs

Depending on your situation, you can look into down payment assistance programs to help you with buying a home. An example of this would be the National Homebuyers Fund, which provides grants to low- and moderate-income buyers equivalent to a 5% down payment. These programs are issued through a government or nonprofit agency and can provide grants or second mortgages.

In addition to this program, you can search for other local home-buying programs offered in your state.

4. Slow down and maximize savings

If you don’t have enough in savings for a down payment, it can be smart to take some time to save up for a down payment as well as other expenses that come with home ownership. To help you reach your savings goal more quickly, create a realistic budget and cut back on any unnecessary expenses. Additionally, put any cash windfalls, such as a raise, bonus, or tax refund, aside to put toward the down payment.

You may also want to re-evaluate how much of a down payment you can realistically afford and potentially lower the cost of the house or car you’re looking to finance. A lower-cost house will require a lower down payment.

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