When getting a mortgage to buy a house, a homebuyer will need a down payment in most circumstances. And though homebuyers don’t always need 20 percent for a down payment, they will usually be penalized if they don’t have that much. They might not be denied a mortgage, but they will typically be required to pay for private mortgage insurance (PMI) to offset the additional risk to the lender. This fee means a higher monthly payment.
Coming up with the 20 percent mortgage down payment in addition to all of the closing costs can be difficult for many homebuyers. As a result, some homebuyers consider getting a personal loan to give them the cash needed for the mortgage down payment and closing costs.
Although this is allowed, it does increase your debt-to-income ratio, which can increase your mortgage interest rate and lower your buying power. It also adds to your overall financial risk. Lets take a closer look at whether or not a personal loan for a mortgage down payment makes sense for you.
Benefits of a Down Payment Loan
Applying for a personal loan can be fairly quick and easy. You can apply online, get a quick decision, and often have the cash within a couple of days. Using a personal loan for a down payment could be a quick way to get the money for a mortgage and move forward with your home purchase.
Interest rates on personal loans can vary from around 5% to 36% APR. On average, the interest rates are lower than you might pay on other methods for quickly accessing cash, such as a cash advance from a credit card. If your mortgage lender is unwilling to negotiate down from the 20 percent down payment, a personal loan might be a reasonable short-term solution to give you the extra cash you need.
Risks of a Down Payment Loan
Even though you may have been approved for a mortgage, nothing is final until you actually sign the loan paperwork at your closing. Your mortgage approval is based on your financial situation on the date of your application.
Mortgage lenders, however, require that applicants continue to provide documentation of income and debt obligations. So, taking out a personal loan can change the lender’s willingness to provide you with mortgage financing under the same terms they originally offered you.
Using a personal loan increases your current debt-to-income ratio because you have a new monthly debt obligation. This is one of the most important financial ratios that lenders consider when underwriting a new mortgage. The higher your debt-to-income ratio, the higher the risk you pose to the lender.
In addition to down payment requirements, lenders have strict underwriting standards related to the borrower’s debt-to-income ratio. Increasing your debt-to-income ratio also lowers the maximum amount that the lender is willing to extend you. So, the personal loan could actually reduce your borrowing power and defeat the purpose of using it to help with the down payment.
Also, having the personal loan on top of the mortgage and all of your other sources of debt can create financial stress. By maxing out what a mortgage lender is willing to give you and taking out a personal loan, you don’t leave much room in your budget for unexpected expenses. Unless you expect an increase in your income in the short term, this can put you in a risky situation where you might not be able to pay your bills.
While a 20 percent down payment is required for a conventional mortgage without private mortgage insurance, there are ways to get a mortgage with a slightly lower down payment. Talk to your lender about other mortgage options. For example, you may be able to get a conventional mortgage with a 15 percent down payment.
Interest rates on these mortgages are slightly higher, and you pay an additional premium every month for mortgage insurance until you build up a 20 percent equity position in the home. If your lender is willing to offer a mortgage with these terms, it is probably a better solution than a personal loan.
Another option could be to consider a Federal Housing Administration (FHA) loan. These mortgages are insured by the federal government and are specifically designed to help first-time homebuyers and lower- to middle-income families who may struggle to come up with a 20 percent down payment.
The maximum value of an FHA loan varies with location and is related to the median home price in that region. Borrowers do pay a higher interest rate on these mortgages but have the option to put at little as 3 percent down on the loan.
Choosing the Best Option
It is legal and permissible to use a personal loan for a mortgage down payment. Although it is a relatively quick and easy way to access the cash you need, it can also be risky and may ultimately end up being counterproductive to getting the mortgage for your home purchase.
If your lender isn’t willing to budge at all on the 20 percent down payment requirement, it might be better to consider other mortgage options that could allow for a smaller down payment. Alternatively, it might be better to wait a little longer to purchase a home so that you can save more for the down payment or consider a lower-priced home.
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