Can you borrow the down payment for a home? If you do it the right way, mortgage lenders will accept a personal loan for down payment. Here’s what you need to know before buying a home.
Buy a home with a personal loan?
It can be a challenge to save a down payment for a first home when you are paying rent and other expenses. And most mortgage programs don’t allow you to borrow your entire down payment unless you qualify for an approved down payment assistance (DPA) program through a government or charitable organization.
But you can borrow your down payment with a personal loan if you plan ahead.
- Determine how much you need to borrow for your down payment and closing costs
- Take out a personal loan and deposit the proceeds into your savings or investment account
- Let the funds “season” for two or three months (you will make your monthly personal loan payments during this time)
- Apply for mortgage preapproval with a lender
- You’ll disclose the personal loan and its payment as a liability, and the entire balance of your savings as an asset, which you’ll use for your down payment and closing costs
Note that the personal loan payment will be part of your monthly expenses and counted in your debt-to-income ratios.
Personal loan for 3% down payment
Both Fannie Mae and Freddie Mac offer mortgages with just 3% down. If you saved $250 a month toward a home purchase, it would still take three years to come up with a 3% down on a $300,000 home. And if the property appreciated at 5% per year, in three years it might be worth $347,000. And then 3% would be $10,410. You’d have to save for six more months!
But you could buy much sooner if you can borrow the $9,000 down payment with a 5-year personal loan. With rates under 6% for well-qualified borrowers, the payment is less than $200. And even at 20%, it’s still less than $250. In 5 years, you’ll have paid off your personal loan and added $9,000 in equity to your home.
What do mortgage lenders consider?
You’re probably wondering what mortgage lenders look at when you borrow your down payment with a personal loan. It’s actually very simple. When you borrow and add the loan proceeds to your savings, the funds become “co-mingled.” The loan proceeds are no longer separate from your other assets.
Leave the loan proceeds in your savings long enough for them to appear in your bank balance (most lenders ask for two or three months of bank statements when you apply for a mortgage). On your mortgage application, indicate that your down payment is coming from “savings.” Because at this point, the personal loan proceeds have been added to your savings.
You don’t state that your down payment is borrowed. But you do disclose that you have the loan and the payment. The monthly payment is part of your debt-to-income ratio. If you already carry a lot of debt, adding another loan payment may reduce the amount you can borrow with a mortgage.
Your debt-to-income ratio, or DTI, is your debt payments divided by your gross (before-tax) income. Mortgage lenders don’t generally like to see a debt-to-income ratio over 43%.
So if your total debt service, including the new mortgage, property taxes and insurance, and all other accounts like credit card minimums, student loans, auto loans and, yes, your personal loan payment come to $2,000 a month, and you earn $6,000 a month, your DTI is $2,000 / $6,000. That’s .3333, or 33.33%. You’d be in a good position to obtain mortgage approval as long as you meet the other program guidelines.
Sometimes, an underwriter might ask about the inquiry from your personal loan provider on your credit history. Answer honestly that it is for the loan which you disclosed on your application. Always be honest on your mortgage application.
Similarly, an underwriter might notice that your savings balance is significantly higher than the average balance noted on your bank statement. You may have to explain the loan proceeds or any other large recent deposits when you apply for a mortgage. The longer the borrowed funds sit in the account, the less likely it is that this will come up.