The most common minimum deposit for a home is currently around 10%, with most lenders preferring a 20% deposit. For most buyers, this minimum is unlikely to equate to anything lower than £10,000, with the average being over £20,000.
In the current climate, cost of living included, this is an awful lot to save up. For many, it takes years and many first-time buyers will find it especially hard to save up this much money alongside all their other expenses.
These circumstances understandably make taking a loan out to use as a deposit look rather appealing. But is it a good idea?
Can I use a loan for a deposit?
Yes, under the right circumstances, it is possible to use a personal loan for a deposit on a house. But like any shortcut, it comes with a catch – or two.
If you haven’t saved up the required amount, you could take out a personal loan to fill the gap. But lenders won’t look at your application as favourably. They prefer to be the only significant debt you’re paying off, and starting your financial commitment with other debts under your belt doesn’t put you in the best position. A personal loan will also show up on your credit rating which ultimately affects your creditworthiness and if your credit rating is already a little weak, bad credit can certainly make it more difficult to get a mortgage.
Whether or not a mortgage provider will still lend to you will depend on your personal circumstances. If you don’t have any other debts and your income is more than enough to cover both the loan and remortgage payments, they might be willing.
Remember that by taking out a loan, you’ll have interest rates to pay on it. These rates may be even higher than the ones on your mortgage repayments. You’ll need to be sure you are prepared to pay both.
Affordability calculations
When lenders look at your application, they carry out calculations on your affordability to pay the mortgage by looking at your income and outgoings; any regular payments or existing loans, direct debits, and daily spendings on things like groceries, entertainment and bills. If you’ve taken out a loan to put down as a deposit, they’ll now also include those loan repayments and interest charges as part of the assessment.
These calculations are what make up your debt-to-income ratio. The lender wants to ensure that your income can easily cover your total monthly debts and still allow you to live comfortably. If you’re paying more to include loan repayments, this might mean the lender offers you less money and at a higher interest rate. Why? Because with more debts to pay, they now perceive you as higher risk.
There are ways to improve this situation. If a loan is the only way you can pay a deposit, you could look at other regular spendings to see if there are some you could drop. If you reduce how much you spend altogether, it might work in your favour.
Can I use a credit card or overdraft for my mortgage deposit?
As these are more high-interest forms of credit, it’s not advised to use them for a mortgage deposit because they’re both risky and don’t look good on your application.
Family loans and gifted deposits
If you’re lucky enough to be able to get an interest-free loan from the bank of mum and dad, this would certainly be a better alternative to a personal loan. Lenders are far more comfortable with deposits raised from interest-free loans, and even more comfortable if it’s an entirely gifted deposit.
Can I take out a director’s loan to use as a mortgage deposit?
If you’re a business owner, you have the option to borrow money from your operations in the form of a director’s loan. It can be used as a deposit for a home, but it comes with tax implications for both you and your business.
Directors’ loans must be included in both the year-end accounts and the company tax return. This mean that the loans are subject to corporation tax, income tax, and maybe even taxable benefits.
If you’re considering using a directors’ loan as a deposit, make sure you speak to a professional and plan it correctly. It could cost you more than it’s worth if you get it wrong, or it could be a strategic use of your funds if done right.
Chris Schutrups, founder of The Mortgage Hut, says:
“Using a personal loan as a deposit is generally discouraged. Lenders are wary of accepting personal loan funds because they suggest higher financial risk. It also increases your debt-to-income ratio, which will give you more difficulty when qualifying for a mortgage. We recommend exploring alternative options like gifted deposits or government-backed schemed that help you secure a mortgage.”
Using a loan of any sort to put down as a deposit is not a common way to buy a home, so it can be hard to find someone who has done it. If a personal loan is definitely the route you want to take, you’ll need is a mortgage broker with experience. An experienced mortgage expert can help you find lenders accepting loan-funded deposits and even advise on your finances to help reduce your perceived risk.
They might even be able to suggest an alternative you weren’t aware of so that you can avoid taking out a loan altogether.
At The Mortgage Hut, we have mortgage experts who have dealt with all sorts of unconventional methods of buying a home and securing a mortgage. Get in touch today and we’ll put you in contact with an expert who can help.
FAQs
Are there any alternatives to using a personal loan for a deposit?
If you’re struggling to save a large deposit, there are a few alternatives you could consider – including government schemes.
You could look at a 5% deposit with the mortgage guarantee scheme or the shared ownership scheme which lets you buy a portion of a home and rent the remainder from a housing association.
Or you could consider using equity from your current property if you’re a home mover, or a pension lump sum as a deposit if you’re nearing retirement.
Where can I borrow money for a mortgage deposit?
Although generally perceived as risky, there are a few ways you can get a loan to put down as a deposit. You could consider a personal loan through a bank or building society, a director’s loan if you’re a business owner, or a loan from family or friends (less risky, especially if there’s no interest).
Is taking out a loan to use as a mortgage deposit a good idea?
Taking out a personal loan to put down as a deposit for a home can be risk. Lenders don’t love it because it means you have more debts to pay and you will have more monthly outgoings to cover than if you were to use your own savings for a deposit. But under the right circumstances, it is possible to do and with help from a mortgage broker you can find a mortgage provider who will lend to you despite it.
