Can You Get A Loan For A Down Payment?

One of the biggest and sometimes most stressful expenses for first-time home buyers is the down payment, which mortgage lenders and home loan programs often require. Even if you’re not putting down 20% of the purchase price – the minimum amount that lenders prefer but usually don’t require – a down payment can be a lot of cash. If you’re thinking of trying to cover a down payment with a personal loan or another loan option, it’s important to be aware of the downsides to this method – and if it’s even a viable option.

Let’s take a look at whether you can get a loan for a down payment, some complications that could arise with this strategy, and some alternative options to consider.

In most cases, a lender won’t approve a mortgage application if you borrow money for your down payment. This is particularly likely if you’re using money from a personal loan. It’s wise to either seek a mortgage loan that requires a small down payment or no down payment, or hold off entirely until you can save up more.

One option that some lenders more frequently allow for is using a 401(k) loan for a down payment. With this type of loan, you could borrow up to 50% of your 401(k) account balance – or $50,000, whichever amount is less. Since this kind of loan is employer-sponsored, however, you risk having to quickly repay the full loan amount if you willingly leave your job or your employer lets you go. If you default on the loan, you’ll be charged income taxes and a 10% early withdrawal penalty fee.

By showing you have money upfront, a down payment – and especially one of a decent size – will make your lender more confident in your ability to make your monthly mortgage payments. A down payment is also a way to give a new homeowner a lower principal balance starting out, which means you’ll have smaller monthly payments and pay less in interest each month and over time. The reason lenders usually won’t allow you to use the funds from a personal loan to make a down payment is because it raises questions about whether you’re in a good financial position to afford the home and all the expenses that come with homeownership.

Government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac – which purchase mortgages from lenders, allowing lenders to provide mortgages to new home buyers – also don’t allow personal loans to be used for down payments.

A lender might also reject your mortgage application since taking out a personal loan raises your debt-to-income ratio (DTI). Mortgage lenders look at your DTI, credit score and other aspects of your finances when reviewing your application, and the loan could raise your DTI above what a lender allows – typically, 43% or less.

Getting a personal loan around the same time you take out a mortgage could also bring down your credit score. The application process for a personal loan requires a hard inquiry of your credit, which goes on your credit report and will cause a slight and temporary drop in your credit score. It’s important for your credit score to be in the best possible shape when you submit your mortgage application so you’re more likely to qualify for the loan and get a good interest rate.

Keep in mind that a personal loan can affect your credit in positive ways, too. However, it’s best to avoid making any big changes to your personal finances during the mortgage process.

In the unlikely event you’re allowed to use a personal loan for a down payment, you could encounter certain hitches in the process. In addition to the aforementioned DTI and credit score concerns, consider:

• You’ll be paying back two loans at once.
• Mortgage lenders may charge a higher interest rate if you borrow money to cover the down payment.
• Personal loan amounts are often in the $1,000 – $50,000 range and rarely higher.
• Personal loan lenders may charge a higher interest rate if you’re using the loan for a down payment.
• The repayment term on a personal loan will be much shorter than the repayment term on a mortgage, and the monthly payments may be higher.

If you need to finalize the purchase of a new house but are waiting for your current home to sell so you can pocket the proceeds for your down payment, a bridge loan is an option perhaps worth exploring.

A personal loan isn’t your only option if you need funds for a down payment. Next, we’ll walk through some alternative approaches to securing the funds you need, so you can see whether they suit your situation.

Apply For A Down Payment Assistance Program

Down payment assistance loans, grants and programs are available to help qualifying home buyers cover the cost of a down payment. The Department of Housing and Urban Development (HUD) offers programs in nearly every state – and you can find your state’s programs on the HUD website.

Approval for down payment assistance will usually require submitting a formal application, and it may mean attending a first-time home buyer class. Requirements related to credit score, income, location and other factors often vary from one program to the next.

Look Into Zero-Down Mortgages

Certain home loans don’t require a down payment of any size, but you’ll still need to meet various requirements.

VA loans – mortgages backed by the U.S. Department of Veterans Affairs (the VA) – don’t require putting any money down. However, to be considered for a VA loan, you must be a current or former service member, a surviving spouse or someone who’s served in the National Guard or Army Reserve. And, even then, you’ll need to meet certain eligibility criteria. Meanwhile, the Department of Agriculture (USDA) offers mortgages for homes in certain rural areas, and these homes likewise don’t require a down payment. USDA loans have other requirements for eligibility, though.

If you can afford a down payment, it’s possible with a conventional loan to make a down payment as low as 3% of the purchase price. However, unless you’re able to put 20% down, you’ll be on the hook to pay private mortgage insurance (PMI) until you reach 20% equity in your home. Mortgages backed by the Federal Housing Administration (FHA loans) allow for a minimum down payment of 3.5%, but you’ll likely need a credit score of at least 580 and you’ll have to pay mortgage insurance in the form of what’s known as a mortgage insurance premium (MIP).

Borrow From Friends Or Family Members

One potentially simple alternative to using a personal loan for a down payment is having a friend or family member loan you the amount you need. Family loans, as they’re sometimes called, often come with a more lenient credit requirement, interest rate and repayment plan, but these loans demand trust between the lender and the borrower. If the loan includes a written contract, it’s a good idea for a real estate attorney to be present when the contract is drawn up.

The family loan for your down payment will still have to be approved by the mortgage lender issuing the home loan, because it still affects your DTI. If the family member doesn’t expect you to repay the loan, it’s not considered a loan at all, but it counts as a gift. In this case, your lender may require a signed gift letter to accompany the funds, but your DTI won’t change.

Wait Until You Can Save Up

If you’re willing to wait to buy a house, it’s typically better to hold off and save up the necessary down payment funds if your loan requires putting money down. Take this time to come up with a monthly savings plan and budget that works for your situation and allows you to set enough money aside to eventually cover the down payment on the house you wish to buy. You should also use this time to improve your credit score, if needed, so you can qualify for the best possible interest rate.

While you’re at it, make sure you have enough cash to also pay your eventual closing costs, which typically are 3% – 6% of the home loan amount.

While using a personal loan for a down payment on a house isn’t a great idea, there are plenty of other reasons to take out a personal loan. A personal loan can be an excellent option if you’re:

• Consolidating credit card debt
• Purchasing a vehicle
• Financing home improvements
• Paying off emergency expenses (car repairs, medical bills, etc.)

Getting a personal loan is a relatively straightforward process, and prequalification won’t bring your credit score down.

Loans can cover numerous expenditures, but using a loan for a down payment on a house could cause more harm than good. Not only do lenders often refuse to approve borrowers using a loan for their down payment, but a loan’s effect on your mortgage interest rate and DTI could make repaying your mortgage harder than it should be. Consider your alternative options, and if buying a house isn’t in the cards right now, create a savings plan.

If you’re seeking a personal loan for any of the other reasons highlighted above, you can get started and apply today with Rocket Loans℠.