When most people think of financing a home, getting a mortgage is usually what springs to mind first. However, a mortgage isn’t your only option. It is possible to buy a home using money from a personal loan. Although it might not be the easiest approach. By understanding the benefits and drawbacks of financing a house with a personal loan, as well as any limitations you may encounter, you can make the right decision based on your situation or preferences.
How Personal Loans and Mortgages Differ
While you could get either a personal loan or a mortgage from a bank or credit union, these two financial products aren’t the same thing. Mortgages are always secured loans.The house acts as collateral. Personal loans may be secured or unsecured, though the majority are the latter.
How much you can borrow also varies by loan type. In most cases, personal loans are significantly smaller than what you can borrow through a mortgage. However, that doesn’t mean a personal loan can’t be large enough for a home purchase. It depends on your area and current property costs.
Finance a House with a Personal Loan: The Benefits
In most cases, the primary benefit of financing a house with a personal loan is that the property is not used as collateral. If your personal loan is unsecured, failing to pay your loan doesn’t mean your home is automatically in jeopardy.
Essentially, foreclosure isn’t an option with a personal loan. While a bank or credit union can take action against you if you fail to pay, they can’t foreclose on the property.
Personal loans may also be a more viable option than mortgages if you are buying a second, third, or any additional property aside from your primary residence. Getting a mortgage for a vacation home or a property you want to flip can be harder than getting on for a house you intend to live in for at least several years.
For example, you may have to put more down to mortgage a second property or may be limited in what you can borrow. Your income may need to be higher for the bank to give you a vacation home loan or your debt to income ratio may need to be smaller.
Personal Loans Can Be Less Stringent
Personal loans are usually less stringent when it comes to certain requirements. This may make it easier to find a lender who will fund your loan.
Finally, if you finance a house with a personal loan, you don’t need a down payment to complete the loan process. While zero-down mortgages do exist, they aren’t as common as other variants. Conventional mortgages usually require at least 20 percent down. FHA loans don’t require nearly as much, but still commonly need a down payment of about 3.5 percent.
Two of the exceptions are VA reverse loans and USDA loans, which allow for 100 percent financing. For a VA loan, you have to be current or former military (or a surviving spouse). With a USDA loan, you may be restricted to certain cities or regions, and there also may be borrowing and income limits.
If you have nothing to put down and don’t qualify for a VA or USDA loan, then a personal loan may be your best financing path, depending on your credit score, income, and other circumstances.
The Drawbacks of Financing a House with a Personal Loan
Since personal loans are usually unsecured, they tend to come with higher interest rates than a traditional mortgage. When you get a mortgage, the home acts as collateral, reducing the lender’s risk since they can foreclose on the property if you default. In return, they commonly charge more favorable interest rates, even if your credit isn’t stellar.
With a personal loan, the lender has no collateral to mitigate risk. As a result, interest rates tend to be higher than a mortgage, especially if you have fair to poor credit. It isn’t uncommon for personal loan APRs to be in the double digits, crossing the 10 percent mark. Bad credit personal loan interest rates can reach as high as 36 percent or more Compare that to the average mortgage interest rate, which is closer to 4.7 percent, and the difference is stark.
One of the other issues you may encounter if you want to finance a house with a personal loan is the loan limit. Most lenders usually offer personal loans at or below $50,000, depending on your income level and creditworthiness.
A few lenders may go as high as $100,000 for an unsecured personal loan, but those borrowers usually have high incomes and excellent credit scores.
Personal loans often have shorter repayment periods than mortgages as well. Many have terms at or below the five-year mark. As a result, the monthly payments can be much higher than a mortgage that last 15 to 30 years.
There are also no tax advantages to a personal loan. Unlike mortgage interest, which might be deductible, you can’t deduct personal loan interest, period.
Should You Use a Personal Loan to Finance Your Home?
From a financial perspective, mortgages are almost always better deals than personal loans. Since the house acts as collateral, you get a better interest rate, which can save you thousands over the life of your loan.
However, if you are buying a relatively cheap property and can get a reasonable interest rate, then keep personal loans on the table. You are allowed to use a personal loan for just about anything, and the seller of the house isn’t going to care where the cash comes from in most cases.
If you go that route, make sure to shop around for the best possible interest rate. Additionally, review your budget to ensure that you can keep up with the payments. That way, you can be as responsible as possible before you go forward with a personal loan.
Did you finance a house with a personal loan? Share your experiences in the comments below.