Do Personal Loans Affect Mortgage Applications?

Kim Franke-FolstadUpdated November 17, 2021

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One of the hardest parts of buying a home can be coming up with the down payment.Forget about rustling up enough for the 20% deposit lenders traditionally like to see. Even the minimum 3% to 5% deposits required for some conventional loans could be out of reach these days, when the median home sales price in the U.S. is currently about $400,000, according to the most recent information from the Federal Reserve Bank of St. Louis. Even buyers who’ve done their research on mortgages — and are confident they can afford the monthly payments for the home they want to purchase — may wonder how they’ll ever manage to put together enough money to get to the closing table.Some buyers may consider applying for a personal loan as a way to get that upfront cash. But it’s an option that has both pros and cons, and it isn’t even always possible to use a personal loan for a down payment on a house.

What Is a Personal Loan?

A personal loan is a type of installment loan that can be used for many purposes, from consolidating debt to making a major purchase like a car or a piece of land. A borrower receives a lump sum of money and is expected to repay the debt in fixed monthly payments, usually with a fixed interest rate, by a predetermined date. The annual percentage rate (APR) on a personal loan can vary depending on the lender, the borrower’s credit and several other factors, including the length of the loan. You can compare personal loan options to research rates and other costs and benefits of personal loans. If you have a good credit score, a personal loan may be a reasonable way to cover a financial need. But when you take out a personal loan — even if it isn’t for a down payment on a home — it can affect your credit score and your ability to borrow money in the future.

Can a Personal Loan Affect Your Chances of Getting a Mortgage?

When you apply for a mortgage, you can expect the lender to thoroughly check your income sources, your credit scores, and your overall credit report to be sure you’re able to responsibly manage the loan. Since you’ll likely be borrowing hundreds of thousands of dollars, the mortgage company will want to be sure there aren’t any red flags that might signal a lending risk. Here are some things the lender could consider and how using a personal loan to buy a house could affect your mortgage application:

Your Debt-to-Income Ratio

One important measure your lender will want to check is how much of your monthly income goes toward making your monthly debt payments. This percentage is known as the debt-to-income ratio (DTI). total monthly debt payments / gross monthly income = DTI Because getting a personal loan for a down payment on a home means you’ll be adding to your total debt, it can increase your DTI. And though your DTI doesn’t affect your credit scores, it can be a big factor in determining if you qualify for a mortgage. You might be able to get a mortgage with a DTI of 45%, and some loan programs allow a DTI up to 50%. But when it comes to checking your borrowing bona fides, the lower your DTI, the better. A DTI of 43% is considered good, and 36% or lower is considered excellent.

How You’ve Managed Your Debt

Of course, the mortgage company will also want to know how well you’ve been managing your debt, so your credit report will be thoroughly reviewed. You can expect the lender to check your payment history to see if you’ve been paying your bills (e.g., student loans, car loans, credit cards) on time. Even if you’ve been paying consistently, the lender also will check your credit utilization ratio to see how much of your available credit you’re currently using. If you’re creeping too close to maxing out your credit cards, or if you have a large outstanding balance on an auto loan, you may appear to be a risk. Most lenders prefer borrowers who keep their credit utilization ratio under 30%. The lender also will be able to see if you’ve recently applied for new debt — including a personal loan for a mortgage down payment. And if you can’t afford your down payment without help, it could be taken as a sign that you aren’t ready for the kind of long-term commitment a mortgage requires.

Moves You Can Make to Improve Your Chances

Your goal when applying for a mortgage is to show that you’re a responsible borrower. So it can be a good idea to check your credit reports and make sure they’re as pristine as possible before you shop for a lender, apply for a mortgage, or broach the subject of using a personal loan to help with your down payment. You can get free copies of your credit reports once a year from each of the three major credit bureaus through AnnualCreditReport.com. (It’s the only government-authorized site for free reports.) If there are any errors, or if you can see your creditworthiness is a little shaky because of past financial mistakes, you can take the necessary steps to clean things up. Remember, the better your credit is, the better the odds that you’ll be able to qualify for a mortgage with a low down payment. If you have at least 3% of your purchase price saved (that’s $12,000 for a $400,000 home), you may not even need to think about getting a personal loan.Another strategy to consider: Lenders might look more kindly on using a personal loan as a down payment if you’re getting both your mortgage and the personal loan from them. So that’s something you may want to ask about.

Is It Possible to Use a Personal Loan as a Down Payment?

The question really isn’t whether you can use a personal loan for a down payment on a home. If you can qualify for a personal loan, you typically can use the money for anything you like (unless your loan agreement states otherwise).The real question is will your mortgage lender accept a down payment that’s paid for with a personal loan? And the answer to that is it depends.If it’s a conforming loan, which means it meets specific guidelines set by Fannie Mae and Freddie Mac, you won’t be allowed to use a personal loan as a down payment. Those government-sponsored institutions don’t allow it. But even if you work with a lender that doesn’t have a set rule against borrowing the money for your down payment, you may want to be cautious. During the underwriting process, the lender might take it as a sign that you don’t have your financial ducks in a row and still turn down your application. And it may limit the lenders and loans that are available to you. So you may want to think of using a personal loan to make your down payment only as a last-resort option.

Pros and Cons of Using a Personal Loan as a Down Payment

As with most financial decisions, there are pros and cons to using a personal loan for a down payment.

Pros

There may be less stress about saving up for a big down payment. Not worrying about where your down payment funds will come from can make the home buying process a bit easier.
You won’t have to tap into your savings account or your retirement fund to get the money for a down payment.

Cons

Some lenders may not allow borrowers to use personal loans for a mortgage down payment. And those who do may still turn down your application if they see it as a sign that you aren’t ready to make such a big purchase.
Your mortgage options may be limited to lenders who are OK with your borrowing the down payment.
You’ll have two payments — personal loan and mortgage — to worry about after you close on your new home.

Other Mortgage Options

If the challenge of putting together a large down payment is keeping you from buying a home, you may want to focus on the types of loans that require little or no money down. Here are a few of the alternatives available:

FHA Loans

Loans backed by the Federal Housing Administration (FHA) require only a 3.5% down payment and a credit score of 580 or higher. (Borrowers with credit scores as low as 500 may qualify for an FHA loan with a 10% down payment.) And that’s not the only source of upfront savings: FHA loans allow sellers to pay up to 6% of the loan amount to cover the buyers’ closing costs. (Sellers can only pay up to 3% on conventional loans.) Also, because FHA loans are backed by the federal government, the interest rates are generally lower than the average rates for conventional mortgages.However, the FHA requires all borrowers to pay both upfront and annual mortgage insurance premiums regardless of the down payment amount. An FHA mortgage insurance policy is designed to protect lenders in case a borrower defaults on a loan.

VA Loans

VA home loans are provided by private lenders, but because the U.S. Department of Veterans Affairs guarantees a portion of the loan, those lenders are able to offer more favorable terms. The VA doesn’t require a down payment, closing costs are limited, and VA borrowers aren’t required to pay mortgage insurance.Veterans, service members, and eligible surviving spouses can qualify. And this is a lifetime benefit, so it can be used multiple times.

USDA Loans

The U.S. Department of Agriculture has two lending programs for qualified homebuyers in rural areas: the Single Family Housing Direct Loan for low- and very-low-income families, and the Single Family Housing Guaranteed Loan for borrowers with a low or moderate income. Both USDA loan programs offer borrowers an opportunity to get a low-interest, fixed-rate home loan with no down payment.

Conventional Loans

Homebuyers who can afford a 20% down payment can avoid paying private mortgage insurance (PMI). So that’s a good savings goal. But it isn't always realistic — and it isn’t typically the amount buyers put down.According to the National Association of REALTORS® 2020 Downpayment Expectations & Hurdles to Homeownership report, the median down payment for first-time homebuyers in 2019 was 6%. And it was just 12% for all buyers that year. If those lower amounts still seem unreachable, there are conventional loans available with a lower down payment threshold — including some for as low as 3% down. But because that low down payment makes you a higher risk to lenders, you’ll have to keep paying for PMI, the insurance that helps a lender avoid financial loss if a borrower defaults on a loan, until you have 20% equity in your home.

Alternative Lenders

There are many lenders, both traditional and online, that offer mortgages with a low or even no down payment. They include well-known lenders like SoFi, Quicken Loans, Bank of America, and PNC Mortgage. You may want to see what these and other lenders have to offer when you compare loan offers, especially if you have a good or excellent credit score, which could help keep interest rates low.

Other Options for Financing a Down Payment

Besides looking for lenders who accept low down payments, it also may be useful to consider alternative ways to come up with the money you need. A few of those might include:

DPA Programs

Down payment assistance (DPA) programs, which are offered by nonprofit organizations as well as federal, state, and local agencies, are available to both first-time homebuyers and those who haven’t owned a home in the last three years. The U.S. Department of Housing and Urban Development website provides links to information about the DPA programs offered in each state.

Keep Saving

There may be ways to save up enough money for a decent down payment even in tight budgets. Earning income from a second job could be a good strategy, as can selling unwanted items to make extra cash. Earmarking tax refunds and gifted money as down payment funds can be a good start to this goal.

Piggyback Loan

A piggyback loan is pretty much just what it sounds like — a second loan that a borrower gets on top of a conventional mortgage in order to make a down payment that’s large enough to avoid paying PMI.The downside to this strategy is that you’ll end up with two new monthly payments to make toward your house instead of one.

Retirement Fund Loan

Another option may be taking a loan from your retirement account. Advantages to this strategy are that there won’t be a credit check and the loan won’t impact your credit score — even if you miss a payment. Another plus: Although you’ll have to pay interest on the loan, the interest will go back into your own retirement account — not to a lender as it would with a typical loan. But, of course, there is a downside. Until you pay back the loan, you’ll miss out on any market gains you might have gotten from your account, and you’ll lose out on the power of compound interest.

Gifts from Family Members or Close Friends

If you’re fortunate, a loved one may offer to give you the money you need for your down payment. (Or you could ask.) But there are restrictions on gifted down payments, depending on the home loan you get. And there are rules for how you’ll have to document the gift amount, as well.

The Takeaway

Coming up with the down payment for a home purchase can be challenging, especially for first-time buyers. There are several strategies that could help, ranging from choosing a lender that accepts a lower down payment to getting a second job to save more money, or getting help from a DPA program or family member.If you’re considering using a personal loan to get the money you need, it’s important to be certain that borrowing your down payment is OK with your mortgage lender. And even if it is, you still may want to weigh the pros and cons of this decision. Taking on a mortgage is a big move, so you’ll want to be sure you can afford the monthly payments as well as the upfront costs.Want to compare personal loan offers from multiple lenders? Check your eligibility with Lantern Credit and see what offers are available from our lending partner network.

Photo credit: iStock/FG TradeSoFi Loan Products SoFi loans are originated by SoFi Lending Corp (dba SoFi), a lender licensed by the Department of Business Oversight under the California Financing Law, license # 6054612; NMLS # 1121636. For additional product-specific legal and licensing information, see SoFi.com/legal.SOLC1021250

About the Author

Kim Franke-Folstad

Kim Franke-Folstad is an award-winning journalist with 30 years of experience writing and editing for newspapers, magazines and websites. Her work for SoFi covers a range of topics related to personal finance, including budgeting, saving, borrowing, and investing.

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