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With the average U.S. home price at $183,500 (and far higher in many major metros) coming up with a 20% down payment is daunting for many homebuyers.
The latest statistics show that most people simply don’t have this four- or five-figure sum, especially those paying high rents. In the fourth quarter of 2015, online lender LendingTree estimated buyers put down an average of 17.46% on a conventional 30-year fixed rate loan.
Some buyers take money from their retirement (which is ill-advised), borrow from family or delay buying a home until they can save enough for a down payment. But there’s another option to consider: a personal loan.
If you have little debt and good credit, you may be able to secure a personal loan from a lender to add to your down payment or to pay for it entirely. However, taking on more debt in addition to a mortgage can be risky.
Here’s what you need to know:
Personal Loans 101
Personal loans are unsecured, meaning you don’t have to put up collateral like a house or car to the borrow money. For this reason, these loans have a higher interest rate than a conventional home loan. Depending on the lender and your credit history, your interest rate for a personal loan can range from 5.49% to as much as 36%.
Compared to home loans, personal loans have shorter terms — typically one to five years. With a personal loan, you’ll have to pay your lender principal and interest each month until you pay off the entire balance. Another thing to keep in mind? Because the loan is spread out over a shorter period, your monthly payments may be higher. You’ll have to consider whether you can afford this cost in addition to your monthly mortgage.
How Mortgage Lenders View Personal Loans
Most lenders require a 20% down payment because it shows the buyer is invested in the purchase. They also require homebuyers to disclose the source of their down payment.
You’ll need to provide records and bank statements to show where the money came from, whether it be your own savings, a gift from relatives or a personal loan from a bank. Most lenders prefer that the funds come from your own pocket, because borrowing from another lending institution could indicate that if you can’t afford a down payment, you may not be able to afford the home. However, if you have enough income to cover this monthly debt, as well as your mortgage, it shouldn’t be a significant issue for your lender.
Personal Loans & Debt-to-Income Ratio
Lenders like to see a debt-to-income ratio (DTI) below 43% — but less than 36% is ideal. Your DTI is a ratio of your monthly income compared to your monthly debt, which can include housing costs, student loans, car loans and credit cards.
Taking out a personal loan can affect your DTI because it increases your debt. If you want to use a personal loan for your down payment, calculate and compare your DTI before and after the loan. If getting a personal loan increases your DTI to the point that a lender would consider you a risky borrower, you may want to borrow less money and save more for the down payment. A high DTI also can affect the type of mortgage and interest rate for which you qualify, increasing your cost of homeownership over the long term.
Personal Loans Can Improve Borrowing Power
Personal loans can positively impact your DTI because you can use them to consolidate other debt at a lower interest rate if you have good credit.
You can transfer revolving credit card debt to a personal installment loan, which also should improve your credit score. If your debt is spread out over multiple credit cards, consolidation will help you because it’s better to owe just one or two lenders than multiple credit card companies. If you aren’t comfortable taking out a personal loan just to consolidate debt, consider a 0% balance transfer card. This will allow you to transfer your existing credit card debt to a new card with a 0% introductory APR for a specified time, which typically ranges from 12 to 18 months. The only caveat is that you must pay off your debt before the introductory period ends. Though you’ll get a longer payoff term with a personal loan, either option will improve your credit score and suitability to a mortgage lender.
Seasoning Your Down Payment
The money for your down payment should ideally be “seasoned,” meaning that the assets in your bank account are at least 60 days old at the time of your closing. If you are going to use a personal loan for your down payment, you can deposit the funds into your bank account in the middle of the homebuying transaction, as long as the terms of the loan are fully disclosed. While not strictly necessary before you apply for a mortgage loan because this will make the lending process a bit easier. Also keep in mind that it takes 60 days for a personal loan to appear on your credit report, but don’t even think about not disclosing the loan to your lender.
Don't Forget Closing Costs and PMI
Even if you use a personal loan to cover your down payment, make sure you have enough money for closing costs, which are typically 3% of the home’s purchase price. A personal loan can cover closing costs and a down payment, but be prudent about how much you borrow. Before you commit yourself to more debt, make sure you have enough income to pay the monthly principal and interest in addition to your 15- to 30-year mortgage loan.
You will also need to account for any required private mortgage insurance, which is typically applied whenever a borrower puts less than 20% down on a property. PMI, as it's called, pays the lender in case you default on the loan.
Before you apply for a personal loan, ensure your lender will accept it as the source of your down payment. If the answer is yes, shop around for the best rate. Credit unions can sometimes off better interest rates than banks, so think about joining your local branch. Online lenders also may offer more attractive rates than brick and mortar lending institutions.
If you’re a first-time homebuyer, consider a mortgage assistance program through your state or local government. National programs through HUD and various charities also make homebuying more affordable. Another option: an FHA loan or another mortgage lender that requires a lower down payment. You can find loans that require a down payment ranging anywhere from 3% to 10%, which is more attainable for most homebuyers.
A Community Seconds mortgage is another option. This homeownership program leverages community, nonprofit and even employer resources to allow qualified applicants to borrow beyond the value of a home, including a down payment and closing costs. For example, Community Seconds loans can be used to fund the down payment on a My Community Mortgage, an alternative to an FHA and conventional mortgage for those within income limits. My Community Mortgage income limits vary by where you live and is typically shown as a percent of area median income.