Can You Use a Mortgage Loan for a Down Payment?

While a new primary mortgage cannot fund its own down payment, other types of loans can provide the necessary cash for a down payment. This article explores common strategies for leveraging borrowed funds, including understanding loan structures, eligibility, and their impact on future borrowing.

Using Your Current Home’s Equity

Homeowners can access their existing property’s equity to finance a down payment. Two options are a Home Equity Line of Credit (HELOC) and a cash-out refinance.

A Home Equity Line of Credit (HELOC) is a revolving credit line secured by home equity. Borrowers draw funds as needed during a 10-year “draw period,” often with interest-only payments. A repayment period, typically up to 20 years, follows, requiring principal and interest payments. Lenders require a combined loan-to-value (CLTV) ratio of 80% to 85% or less, meaning your existing mortgage and the new HELOC cannot exceed this percentage of your home’s value.

Qualification for a HELOC requires a credit score of 650 or higher. Lenders also assess your debt-to-income (DTI) ratio, seeking 43% to 45% or less.

A cash-out refinance replaces your current mortgage with a new, larger one, providing a lump sum for a down payment. Conventional cash-out refinances allow borrowing up to 80% of your home’s value, requiring 20% equity. Government-backed loans, such as FHA and VA cash-out refinances, offer higher loan-to-value (LTV) limits; VA loans can allow up to 100% LTV, though lenders often cap it at 90%.

Eligibility requires a credit score of 620 or higher for conventional loans, or 580 for FHA loans. Lenders seek a debt-to-income (DTI) ratio no greater than 43% to 50%. Cash-out refinance rates are slightly higher, typically 0.125% to 0.5% more, than standard refinances. These loans involve closing costs similar to a new mortgage.

Exploring Other Borrowing Options

Beyond home equity, other borrowing options can secure funds for a down payment. Personal loans and 401(k) loans are common examples.

Personal loans are unsecured, meaning they do not require collateral like a home. This often results in higher interest rates compared to secured loans. Interest rates vary widely based on creditworthiness. Lenders assess eligibility through credit score and income, preferring scores of 660 or higher. A lower debt-to-income ratio, ideally below 36%, also improves approval chances and terms.

Borrowing from a 401(k) retirement account is another option, effectively a loan from your own savings. The IRS allows borrowing up to $50,000 or 50% of your vested account balance, whichever is less. Repayment is typically through automatic payroll deductions over five years, or longer if used for a primary residence. Interest paid is credited back to your account, unlike traditional loans. A key advantage is no credit check and no impact on your credit score.

Qualifying for a New Mortgage After Borrowing

Taking on additional debt for a down payment directly impacts qualifying for a new primary mortgage. Lenders evaluate financial health, emphasizing the debt-to-income (DTI) ratio. Understanding these new obligations is important for prospective homebuyers.

The debt-to-income ratio (DTI) assesses a borrower’s capacity to manage monthly debt payments relative to gross monthly income. This ratio sums all monthly debt obligations, including the new down payment loan and projected mortgage payment, then divides by gross monthly income. Lenders prefer a DTI of no more than 36%, though some approve up to 43% or 50% with compensating factors like strong credit or financial reserves. A higher DTI signals increased financial risk, potentially leading to loan denial or less favorable mortgage terms.

Applying for new credit, such as a personal loan or HELOC, results in a hard inquiry on your credit report. A single hard inquiry has minimal impact, often lowering a credit score by a few points. However, multiple inquiries in a short period can raise lender concerns. Mortgage lenders perform a final credit check before closing to ensure no significant new debts. Therefore, avoid applying for new credit or taking on substantial new debt during the mortgage application process, as this could negatively affect your credit score and DTI, jeopardizing approval.