Lenders require borrowers to make a mortgage deposit as a sort of entry fee to get a deal, as it demonstrates financial strength and lower risk. However, as property prices and minimum deposit amounts rise, many seek alternative methods to raising capital to get their foot on the property ladder. One of the methods clients at When the Bank Says No ask about is borrowing money to pay the mortgage deposit.
Our answer? It’s not recommended, but it’s certainly possible. In this article, we will explore how viable it is.
Why is a mortgage deposit best paid without a loan?
When mortgage lenders are considering applications, they are looking for financial stability so that you can “pay rent” in the form of monthly mortgage payments. One of the ways this is demonstrated is with a mortgage deposit. There are no set maximum or minimums for deposits, only averages.
The average minimum deposit amount is 5% of the house’s property value, but these low deposit mortgages only apply to the safest borrowers, whereas first-time buyers pay 20%. The only reason that larger deposits would be required is if the borrower is considered a risk.
How much deposit you pay is one of a few factors, including term length and interest rate deal, that determine the monthly repayment amount. That aside, how you pay the mortgage deposit affects eligibility. Mortgage lenders will ask how you plan to pay for it, and if your answer is a loan with set repayment times with interest attached, chances are you’ll be rejected. Having additional outstanding loans increases debt-to-income ratio, and the higher that is, the more it threatens your ability to make your mortgage’s monthly repayments.
Mortgage providers will look at all factors of your mortgage application, including monthly income and approximate annual income.
What Loans Do People Use For a House?
Knowing the rules of a mortgage deposit modifies how you should approach using a loan to secure a property. But what kind of loans do people usually go for?
Personal Loan
A personal loan is classified as an “unsecured loan”, meaning it doesn’t require the borrower to put up collateral against the loan. This usually means credit ratings are the main way to determine how reliably you can pay off the money you are borrowing.
As we said before, this mortgage deposit payment method is looked down upon. The reason for this is that you’ll be paying off the heavy interest of two loans at once. It’s a very good possibility that the offer of paying the housing deposit with a personal loan will result in mortgage lenders rejecting you outright, as they consider it too big a risk.
Secured Loans
A secured loan allows people to borrow money with much less risk by utilising collateral. The collateral is, of course, a high-value asset, such as a car or property.
Lenders accept these types of loans more than personal loans because interest rates are more manageable. Aside from the monthly outgoings, however, there is also the asset to consider. For example, loss of a vehicle could affect work if transportation is vital, which in turn makes meeting mortgage payments harder.
Family Loans
To take a family loan is to borrow money from a member of your family, and may or may not have repayment terms. This is considered a safe source, as they understand mortgage repayments come first and tend to be lax on repayment.
There is no reason whatsoever for mortgage providers to decide against an application from someone borrowing money from a family member. This is because there’s no enforceable action or existence of a competing loan with interest, many lenders consider this a safe option, provided it doesn’t come with an unfavourable contract.
Guarantor Loans
A guarantor is someone who agrees to be responsible for repaying a loan if the main borrower defaults, essentially acting as a safety net for the lender. Upon signing the contract, the guarantor becomes legally responsible. A secured guarantor loan borrows against their assets, such as the guarantor’s home.
These types of loans are not all that common in general, but they are often accepted by lenders provided the guarantor’s financial situation seems stable. It’s also a fact that borrowing capacity is enhanced, sometimes going up to 100% of the property’s value, potentially eliminating the need for a housing deposit.
Using a Loan for a House Deposit – Pros and Cons
There are a few things you should know when taking out a loan for a mortgage deposit.
Pros
- Saving preservation – Having a savings account provides a lot of security for both emergencies and investments. Emptying it can leave a lot of people feeling vulnerable again.
- Quick access to funds – Most loans are given within 1-2 weeks, with secured loans taking up to a month to gain access to. This is a huge bonus for those opportunists familiar with the cycle of house prices and lock in the approximate value of a home before it rises.
- Bigger deposit – The default process is to put up a small deposit against the purchase price, but a loan allows for a larger deposit due to the extended possibilities, lowering the overall loan-to-value.
Cons
- Increased interest rates – You will have to contend with high rates of interest for non-secured, non-family loans, and this is on top of the mortgager’s interest.
- Mortgage eligibility – Probably the biggest concern is that most mortgage lenders outright refuse to lend money to you. If the money being borrowed for the deposit incurs a high-interest rate, then they may consider the risk too great to chance.
- Higher debt-to-income ratio – If much of your income goes to paying off debts, this will reduce your debt-to-income ratio. This can reduce your quality of life and prevent you from appropriately responding to an emergency. Debt-to-income ratio is one of the things most mortgage lenders look for, as many begin to look unfavourably upon a ratio higher than 50%.
Our Deposit Suggestion
Here at When the Bank Says No, we would ordinarily advise against using a loan for a mortgage deposit. Creating a mortgage deposit saving strategy is a much safer avenue if family members, who are usually the go-to, are unable to help. That being said, depending on your situation, another type of loan for a mortgage may be acceptable. For example, a secured loan against an asset that wouldn’t compromise your ability to make monthly payments if lost.
If you are struggling with how much deposit you can put up or hitting stumbling blocks when trying to get a mortgage with a loan for a deposit, our suggestion is to hire an expert mortgage broker who has the skills and connections to help you achieve mortgage solutions. Mortgage brokers make it their full-time job to understand mortgages inside and out and can help you even if you are struggling with a mortgage deposit. No need for a broker matching service – contact us today and we’ll help you perfect your mortgage application, compare acceptable loan options, find a mortgage provider and more.
Conclusions
While using a loan for a deposit isn’t the most common or easiest way to get mortgage approval, it nonetheless offers a way forward for those who may not have a real prospect of getting together a deposit in the immediate time, but don’t want to miss out on a property.
Securing a mortgage with a loan is possible. To explore this and alternative routes to your dream home, consider hiring impartial advice from one of our mortgage experts. When the Bank Says No are experts in the mortgage realm, with a network of specialist lenders and a host of experience tailored for your specific situation.
Using a Loan for a House Deposit – FAQs
Can I Use a Credit Card for a House Deposit?
It’s entirely possible to use a credit card to pay a house deposit, but it’s not recommended. This is for much of the same reasons that a personal or secured loan may prove detrimental – they signal to most mortgage lenders that you may have other debts or difficulties making mortgage repayments. On top of this, there may be additional transaction fees/surcharges that will add to the overall cost.
What Happens if the House Purchase Falls Through After Taking a Loan for the Deposit?
If your house purchase falls through after taking a loan for a deposit, several things may happen:
- Mortgage offer – If the house purchase falls through, the mortgage offer is likely now invalid. A mortgage lender may allow you to transfer the mortgage over to another property, but it’s also a good possibility that you’ll need to redo your application in its entirety. The most immediate thing you should do if the purchase falls through is speak to your mortgage lender as soon as possible.
- Deposit refunding – Upon the house purchase falling through, you usually will get your deposit back. The only instances in which you won’t are the ones in which some terms say otherwise.
- Loan repayment – It’s likely that unless you get your loan from family/friends, you will still be responsible for the loan repayments. This means you’ll be making monthly repayments as agreed upon, including the interest.
Are there Government-backed Loans Specifically for House Deposits?
There are several, yes:
- Mortgage Guarantee Scheme – Launched in April 2021, this scheme is designed to increase the supply of 5% deposit mortgages. It’s applicable for first-time buyers and current homeowners for properties under £600,000 and is available until June 2025.
- First Homes Scheme – Launched in June 2021, first-time buyers in England can apply and achieve a 30% discount against the market price of homes. The local authority determines eligibility criteria.
How do lenders verify the source of the loan used for house deposits?
Lenders ask for evidence to tally up and make their determination about your ability to repay. Bear in mind that we always recommend being honest with lenders, as it may result in consequences down the line.
- Bank Statements – Most lenders will always ask for bank or building society statements as evidence of incoming and outgoing finances. If they see an incoming payment from a company, they can look up that company to understand the nature of the payment.
- Sale of Property – If selling an asset, they will require official documents demonstrating the sale.
- Legal Agreement – For a gifted deposit, lenders will expect to see a legal agreement between you and the gifter or family member. This will often be in the form of a gifted deposit letter whereby the gifter confirms it is their own money, the gift is not a loan, and they have no stake in the property being bought.
It is worth noting that cash deposits are usually not accepted due to difficulty in tracing and inability to meet money laundering laws.
How will borrowing money affect my credit rating?
Your credit rating will suffer in the short term if you take out a loan for a mortgage deposit, because it increases your debt-to-income ratio. The more money you borrow, the closer you come to your credit limit.