Can You Take Out a Personal Loan for Closing Costs?
If you’re buying a home, it’s important to remember that your expenses go beyond the actual sale price.
You’ll spend a lot of your own money on the down payment and closing costs.
These are two of the biggest hurdles to homeownership, with many loans requiring a minimum down payment between 3 percent and 5 percent.
Some homebuyers save up for these expenses, whereas others use gift funds or assistance programs.
But these aren’t the only ways to drum up cash for mortgage-related costs. Using a personal loan is sometimes another option.
But while most mortgage lenders won’t allow you to use a personal loan for your down payment, they might allow a personal loan to cover your closing costs (lender and third-party fees).
Here’s what you need to know when looking for a personal loan, as well as when it makes sense to use one for closing costs.
What to Look For When Using a Personal Loan for Closing Costs?
Personal loans are installment loans issued by banks, credit unions, and online lenders.
They’re attractive because they’re often unsecured, plus you can use funds for just about any purpose.
Common uses for a personal loan include:
- Debt consolidation
- Home improvement
- Other large purchases
When it comes to closing costs, some people don’t think to use a personal loan. Yet, this source can provide cash when you’re short on money, or if you don’t want to deplete your savings on a home purchase.
Even if you've been diligent about saving your money, what you have in reserves might not be enough for closing.
After applying for a loan, your lender will provide a Loan Estimate within three business days. This document estimates how much you’ll pay in closing costs.
If you don’t have this much in savings—and don’t think you’ll save enough before closing—a personal loan can keep your closing on schedule.
How do you choose a personal loan?
1. Interest rate
Rate shopping can help you get the best rate. Start by contacting a minimum of three lenders to get a rate quote, and then compare their offers.
Keep in mind:
These lenders will check your credit, so rate shopping can cause a slight, temporary dip in your credit score.
But if you rate shop within a 14 to 45-day window, these multiple inquiries will only count as a single inquiry, causing little damage to your score.
2. Loan amount
You want a personal loan to cover what you need for closing, so it’s best to apply only after you’ve received a Loan Estimate from your mortgage lender. This way, you know how much to ask for.
Of course, Loan Estimates are just that—an estimate.
Your actual closing costs could be more or less.
You won’t know the actual amount until about three days before closing. At which point, it’ll be too late to apply for a personal loan.
To avoid delays:
Make sure you have some cash in reserves, in the event that your closing costs are slightly higher than the amount of your personal loan.
You can pay the difference and keep your loan closing on schedule.
3. Repayment terms
Since closing costs are typically between 2 percent and 5 percent of the loan amount, you might be able to pay off a personal loan within a few years or sooner.
Regardless of whether you receive a repayment term of 12 months, 24 months, or 36 months, make sure you can afford the monthly payment.
You’re taking on a new mortgage payment, too, which could be higher than your current house payment. And if you’re purchasing a bigger home, you can expect an increase in utilities.
Make sure you account for new expenses associated with the home purchase, and then choose a personal loan repayment term that doesn’t complicate your finances.
Be mindful that personal loans also have fees.
Some banks will charge a loan origination fee which covers expenses associated with creating the loan.
Also, many personal loans have a prepayment penalty. Banks make money from interest, so the longer you keep the loan, the more they earn.
To discourage borrowers from paying off their loans early, some banks charge a fee when you pay off a loan before a certain timeframe.
This penalty can be a flat fee, or an amount equal to several months of interest.
Common Personal Loan Fees
|Type of fee||Typical cost|
|Application fee||$25 to $50|
|Origination fee||1% to 6% of the loan amount|
|Prepayment penalty||2% to 5% of the loan amount|
|Late payment fee||$25 to $50 or 3% to 5% of monthly payment|
|Returned check fee||$20 to $50|
|Payment protection insurance||1% of the loan amount|
What Are Some Fees Associated With Closing Costs?
If you get a mortgage loan for $200,000, you might pay between $4,000 and $10,000 in closing costs.
What do these third-party and lender fees include? And most importantly, which fees are your responsibility?
Buyers and sellers both pay closing costs, although they’re often associated with the buyer.
Closing costs for buyers include the following:
- Origination fee
- Application fee
- Title insurance
- Home inspection
- Prepaid interest
- Homeowners insurance
- Prorated property taxes
- Recording fee
- Credit report fee
- Notary fee
- Loan discount points
Sellers have fewer closing costs, but they tend to spend more because they’re responsible for paying commissions to both agents.
On average, sellers pay a total of 8 percent to 10 percent of the sale price, with 6 percent allocated for commissions.
Other seller closing costs can include:
- Transfer taxes
- Credits toward closing
- Prorated property taxes
- Attorney fees
When Does It Make Sense?
But although it’s possible to use a personal loan for closing costs, should you?
This approach doesn’t make sense for everyone. And knowing whether it’s the right choice for you can prevent jeopardizing your mortgage loan.
If you’re thinking about using a personal loan for closing costs, notify your mortgage lender immediately.
You need to make sure the personal loan won’t impact your mortgage approval.
If the bank knows your intent—and how much you plan to borrow—they can run the numbers and determine how this additional debt payment will affect your mortgage.
The reality is:
Taking on a debt payment increases your debt-to-income ratio. This could reduce your mortgage qualifying amount.
Also, applying for a personal loan creates a new inquiry on your credit report. This can shave a few points off your credit score.
If you have a high score, a new inquiry might not make a big difference in terms of interest rate. But depending on where you stand credit-wise, even the slightest drop in score could result in a higher rate.
The bottom line: Using a personal loan for closing costs only makes sense if it doesn’t hurt your chances of getting approved or securing a low rate.
How to Increase Your Chances of Approval
Improving your credit score can increase your chances of getting approved for a personal loan and a mortgage loan.
If you’re applying for a personal loan within a few weeks, there isn’t a lot you can do to boost your score.
But if you have some time, make sure you pull your credit report and check it for accuracy.
Credit report mistakes can hurt your score, resulting in credit denials and higher interest rates. If you find any errors on your reports, dispute these with the credit bureaus.
Additionally, pay off some of your credit card debt. This can improve your credit utilization ratio which also gives your credit score a boost.
And again, taking these steps to improve the odds of getting approved for a personal loan also helps with the mortgage process. Homebuyers with the highest scores qualify for the best rates and enjoy lower monthly payments.
Even though a personal loan can provide extra cash for closing costs, it does create another debt and increases your monthly expense. So consider other alternatives, too.
For example, when submitting your offer to buy a home, ask or negotiate for the seller to pay your closing costs. Some mortgage programs (FHA and conventional) allow sellers to contribute up to a certain percentage to a buyer’s closing costs. This reduces how much you have to bring to closing.
Another option is to work with your lender and wrap your closing costs into the mortgage balance. This is an option when there’s enough equity in the home, in which case the final loan amount doesn’t exceed the value of the property.
Also, some lenders will pay a buyer’s closing costs. However, this typically requires agreeing to a higher mortgage rate, which could end up costing more in the long run.