While it is technically possible to get a loan for the down payment on a home it can create some significant challenges when you apply for a mortgage so there are many points to consider. When you take all of these points into account, you can understand why most people do not get a loan for their down payment to buy a home.
The first point to keep in mind is that you are required to disclose all loans and debts you are responsible for when you apply for a mortgage, including any down payment loan from a relative or friend that may not show up on your credit report. The lender reviews the terms for all loans to understand the required payment and any collateral used for the loan.
If the property you are buying is used to secure the down payment loan then the lender may not permit loan and will definitely not allow the loan if it takes priority over your mortgage. Loan priority reflects the order in which the loans are recorded as well as when you are required to repay your loans and claims on the property in the event of a default. In short, mortgage lenders require that their mortgage has first priority so they get repaid first.
Lenders may permit a down payment loan if it is junior, or second in priority, to the mortgage but only if the total combined loan amount does not exceed the lender’s maximum loan-to-value (LTV) ratio. The LTV ratio effectively limits the total amount of loans on a property relative to the value of the property. Lenders usually apply a maximum LTV ratio of 75% to 97%, depending on the lender and loan program. The lender uses an LTV ratio limit to help ensure that they recover their loan if you cannot repay the mortgage.
For example, if you want to buy a home for $100,000 and you obtain a mortgage for $80,000 (80%) and a down payment loan for the remaining $20,000 (20%), your LTV ratio is $100,000 which may exceed the lender’s LTV ratio limit and prevent you from qualifying for the mortgage. It is important to understand the lender’s LTV ratio guideline if you are considering a down payment loan.
The final point to understand about a down payment loan is that any monthly payments you are required to make are included in your debt-to-income ratio which impacts what size mortgage you qualify for. The higher your monthly debt expense, the lower the mortgage amount you can afford. So if your down payment loan or monthly payment are too high you may not be able to get approved for the mortgage you need to buy the home.
It is important to highlight that there are alternatives to paying for your down payment besides getting a loan. We provide a comprehensive review of Down Payment Assistance Programs, including grants and subordinated second loans. These programs can help you pay for part or all of the down payment to buy a home and are implemented with the full cooperation and coordination of your mortgage lender.
There are also numerous low down payment mortgage programs that minimize or eliminate the need for a down payment loan. In some cases you can combine a down payment grant with a low down payment program to buy a home with minimal personal financial contribution.
These programs are usually much simpler and more cost-effective ways to help you pay for the down payment to buy a home than a loan from a friend, relative or other source.