Why Using a Personal Loan as a Down Payment for a Mortgage is a Bad Idea

A mortgage down payment should ideally be at least 10 percent of the total value of the home. Where possible, paying at least 20 percent down can greatly reduce the cost associated with ownership. With a 20 percent down payment, the cost of mortgage insurance is cheaper or completely removed. The total limits are also lower, making the loan shorter and more affordable. Unfortunately, simply saving the cash for a large down payment is often very challenging. You may be tempted to take a loan for the down payment, but this is a bad idea in most scenarios.

Interest Charges

You will pay interest on the personal loan you take for a down payment. The loan will typically come with high interest rates, in fact, due to the nature of a personal loan. Personal loans are rarely secured with an asset. They also tend to be short-term and high-risk. A lender will charge you a rate much higher than that assessed with a standard, low-risk debt. You will end up paying an additional 7 to 10 percent of the total cost of the down payment as a result. This means a $40,000 down payment on a $200,000 loan can actually cost you over $50,000 once interest compounds. 

Total Debt

The total debt you take on during the beginning of your mortgage will be astronomical if you borrow your down payment. Instead of providing a $40,000 down payment and taking a $160,000 mortgage, you are borrowing the entire $200,000 in the above example. This means your monthly payments before the personal loan is paid off will be double. You will have to pay once toward the personal loan and once toward the mortgage. Borrowers are typically paying the largest portion of their income, percentage-wise, during the beginning of a mortgage. Add to this the personal loan payment, and you may find your debt is out of hand at the beginning of your loans.

Security against Bankruptcy

Emergencies do happen that can cause default on your loans. With an average mortgage, the home can be sold to avoid foreclosure. Even if the home enters foreclosure, the debt can be met through repossession and liquidation of the asset. The equity the home owner has, i.e., the down payment plus monthly payments, is used to cover interest balance on the debt. If you do not actually have equity in the home, the interest balance cannot be covered. This means foreclosure could lead to bankruptcy if you cannot find another way to cover the remaining sum.

Mortgage Loan Rates

You may think your mortgage lender will not know where you got the money for the down payment. The opposite is true. You will need to secure the personal loan before a mortgage, and it will show up on your credit score. A mortgage lender will look at this and realize you have a lot of debt and were unable to save for a down payment. This turns your loan into a high-risk loan. Rates on high-risk loans are far higher, and your mortgage will be more expensive as a result.

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