You might consider using a personal loan as a deposit simply because you haven't saved enough. But borrowing money twice, for both the loan and the deposit, will put you in a much worse position financially.
And if you haven't saved a 20% deposit, you'll end up paying lenders mortgage insurance (LMI) premiums. It's possible to avoid LMI by using a personal loan to cover part of your deposit instead, but this is also a risky alternative.
How to use a personal loan for a house deposit
When buying a home, lenders need you to save at least a 5% deposit. There are some no deposit exceptions, but only in specific cases and you'll generally need parental or government help.
If you wanted to buy an $800,000 house then a 5% deposit would cost you $40,000. And you'd have to borrow the remaining $760,000 (and pay a small fortune in LMI premiums).
In theory you could borrow the $40,000 as a personal loan, borrow the rest as a home loan and repay both debts. Most lenders would reject your application immediately because they need evidence of your savings to trust you can repay the loan. And a $40,000 debt with high interest rate is the opposite of that.
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As a rule, most lenders need you to have at least 5% of a deposit in genuine savings.
How to avoid paying LMI with a personal loan
LMI is expensive. In the example above, if you bought an $800,000 house with a 5% deposit the LMI premiums would exceed $34,000.
You could avoid LMI by taking out a personal loan. If you had a 5% deposit you'd need to borrow a further 15% to make a 20% deposit. Once you hit 20% of a property's value, lenders don't charge LMI.
While this approach could work, taking out a personal loan to avoid LMI means taking on a second debt and increases your monthly repayment obligations by a lot.
Does borrowing a house deposit with a personal loan save you money?
So when you avoid paying LMI by taking out a personal loan for part of your deposit, will it actually save you money in the long run?
The answer is more complicated than you might think. Here's a hypothetical scenario.
Harriet and James buy a house
Harriet and James are looking to buy their first home with an estimated property value of $600,000. They have a 10% deposit of $60,000. This means their loan amount is $540,000. Their LMI premium is an estimated $11,772 according to Finder's LMI premium calculator.
Here's how the couple's costs break down depending on whether they buy a house with a 10% deposit and pay LMI or use a personal loan to bring their deposit up to 20%.
Small deposit, paying LMI
Assuming a home loan interest rate of 2.00% over 30 years and a $540,000 loan amount, here are Harriet and James's costs:
- Monthly repayments at 2.00% over 30 years = $1,995 a month.
- They pay $178,540 in interest over the life of the home loan.
- LMI costs = $11,772
You can use Finder's home loan repayment calculator to check the maths for yourself.
Using a personal loan
What if the couple decide to borrow a further $60,000 as a personal loan? This would bring them up to a 20% deposit and save them over $11,000 in LMI premiums.
Their home loan amount falls to $480,000 but they now have 2 loans to repay. Let's assume the couple take out an unsecured personal loan with a reasonable rate of 7.50% over 6 years.
- Home loan repayments at 2.00% over 30 years = $1,774 a month.
- They pay $158,702 in interest over the life of the home loan.
- Their personal loan has a rate of 7.50% over 6 years. Your monthly repayments = $1,037.
- Over the 6-year life of the personal loan they pay $14,693 in interest.
You can use Finder's personal loan repayment calculator to check the maths for yourself.
All together, Harriet and James's loan costs in this scenario are:
- Total monthly repayments (on 2 loans) = $2,811
- Total interest costs (on 2 loans) over 30 years (6 for the personal loan) = $173,395
By avoiding LMI and getting a personal loan to make up the 20% deposit, the couple actually pay less overall. This is because a 6-year debt, even with a higher interest rate, ultimately costs less interest than a 30-year mortgage debt. But the downside is the much higher monthly repayments. The average borrower is probably not in a position to pay that much every month.
If you avoid LMI and get a personal loan instead, your monthly loan repayments are much bigger. In the long run you technically pay a little less interest because you repay the personal loan debt much faster. But those monthly repayments are very high.
Capitalising LMI
But Harriet and James could borrow the LMI costs along with their home loan. This is called capitalising LMI. In the example above, buying a home with a 10% deposit and LMI would mean a loan amount of $551,772 instead of $540,000.
In this scenario (30-year loan with a rate of 2.00%), the monthly repayments would rise to $2,039. That's only $44 a month more.
Is it a bad idea to use a personal loan as part of my deposit?
As the numbers above show, you could technically save on interest by getting a personal loan to cover part (though not all) of a deposit. But it's not a great idea. Taking on 2 debts increases your risks and drastically increases how much you have to repay each month.
Lenders may also reject your application because a personal loan will impact your credit score. You look like a riskier borrower when you have a small deposit and a second debt too.
Also, with a small deposit and multiple debts, you don't have much equity in the property. This means you don't own much of your house. It's mainly debt. Given that you can also capitalise LMI costs and borrow them with the loan, paying LMI lets you both enter the property market sooner while avoiding the extra monthly costs of paying off 2 loans.
If you're thinking about avoiding LMI by taking out a personal loan, it's recommended that you consult your lender directly to discuss the terms and features of their loans, as well as their LMI provider policies.
Get a guarantor and buy a house with no deposit or personal loan
If your parents own their own home and really like (or trust) you, you might be in luck. Your parents could as a mortgage guarantor, use the equity in their home to back your home loan application. If a lender agrees, you might be able to borrow 95% or even more of your property's value and avoid LMI.
It isn't an option for most buyers but it does work for some.
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Hello, We are looking at purchasing our dream land for 210k, and then building on it in the middle of next year once we have saved more. total loan will be approx. 600k once built.
Our initial cash deposit is only $11k so we are borrowing 20k from a pl to make the difference. for the deposit.
How hard is it going to be for us to borrow on a construction loan next year if we have the land loan and the personal loan?
You should really talk to a lender about this. It’s probably not impossible but it’s quite risky to use a personal loan as a deposit.