Can you use a personal loan for a down payment on a house?

You cannot use a personal loan for a down payment on a house. Mortgage lenders will almost never allow it. That’s because Fannie Mae and Freddie Mac, two government-backed companies that guarantee conventional loans, have rules against it.

The point of a down payment is that you’re paying some amount of the cost of the home up front in cash. This reduces the lender’s risk if you default. But if you take out a loan in order to get that cash, you’re just taking out debt to pay off debt. You’re not tapping in to your savings, and your debt load is the same as if you didn’t make a down payment at all. Taking out a loan for a down payment also will increase your debt-to-income-ratio, which can complicate approval.

Why You Can’t Use a Personal Loan for a Down Payment on a House:

1. Mortgage Companies Have Rules Against It

Personal loans can be used for just about any purpose, as long as it’s not illegal or gambling. But that doesn’t mean every company will accept money that came from a personal loan. Mortgage providers, following the rules set by Fannie Mae and Freddie Mac, will almost never accept a down payment that comes from another loan.

2. It’s Difficult to Pay Debt With Debt

Making a down payment demonstrates that you’re financially responsible enough to pay some of the cost at the start. It guarantees that the mortgage lender receives some of the payment they are due. If you default, the lender won’t have to wait to resell the house before they can recoup some of their funds. Naturally, lenders want you to pay down payments out of cash you already have saved up, not money you borrowed (which would increase your chances of default).

3. It Increases Your Debt-to-Income Ratio

Your debt-to-income ratio measures the amount of your gross monthly income that gets used for paying debts. The higher this ratio is, the less likely you are to be able to handle additional debts. Taking out a personal loan for a down payment would increase this ratio before you even applied for the mortgage, thus making it a lot more difficult to qualify.

Plus, taking out a personal loan for a down payment would cause a hard inquiry into your credit report before you applied for the mortgage. That too would hurt your score and your chances of being approved.

4. You Can’t Sneak it By Your Mortgage Issuer

Your mortgage lender will pull your credit report, so they’ll be able to see if you’ve taken out a loan or not. They will also require you to tell them the source of the money for your down payment. And some mortgage lenders might insist on the funds being “seasoned,” meaning they’ll need to sit in a bank account for a specified period of time before being used as a down payment.

5. You’d Have Two Loans with Expensive Interest

Even if you could use a personal loan for a down payment on a house, it wouldn’t be a good idea. Placing a bigger down payment can get you a lower APR on your mortgage, but you would accrue more interest on your personal loan at the same time. The best-case personal loan rate would be around 6% and worst would be 36%. You’d have to make simultaneous payments on both the mortgage and your personal loan.

How to Make a Down Payment on a House

The best way to make a down payment is to save up your money until you have enough to make a down payment in cash. Acceptable sources of funds include savings, retirement funds, investments and gifts. You could also just make a lower down payment if you’re willing to accept higher interest rates on the mortgage itself and are willing to purchase private mortgage insurance (usually required for down payments smaller than 20%).

Another option is “piggybacking” a home equity loan or home equity line of credit onto your mortgage. This allows you to borrow additional money to supplement whatever smaller down payment you can make. The most common example is referred to as “80-10-10.” You take out a mortgage for 80% of the house’s value, make a 10% down payment with your own money, and then make another 10% down payment with money from the home equity loan or HELOC. This lets you avoid having to pay for private mortgage insurance because you technically are making a 20% down payment. But you’ll then have to juggle two loans which add up to 90% of the home’s value, which isn’t ideal.

You could also borrow from a 401k for a down payment since it’s your personal savings – but you have to pay the full amount back to your account, plus interest, within 5 years or you’ll owe a 10% early withdrawal penalty and income taxes. And if you lose your job, you’ll have to pay this loan back on the tax day for the year in which you lost your job, instead.