It's possible, in certain circumstances, to use a loan for a house deposit, but many lenders will not accept this method. It's also not optimum for your finances, as you'll be repaying two loans with interest at the same time. While saving a cash deposit is the best option, it’s not possible for all prospective homeowners. We look at how to go about securing a mortgage using a loan as the deposit, and what to consider if you do.
With mortgage rates and property prices high at the moment, it could take several years for the average buyer to scrape together enough money for a deposit. Even borrowing at 95% LTV (where you only need 5% deposit) would still require a minimum deposit of £18,644 for the average property - which costs £372,894*.
It’s understandably tempting, therefore, to take out a loan for a mortgage deposit, or at least part of it. But putting yourself in debt to secure even more debt isn’t ideal - and mortgage lenders will be put off if you already have high levels of borrowing.
*May 2023, Rightmove
Some loan providers may be willing to lend to you if you intend to use the funds for a mortgage deposit. There are also mortgage lenders who will consider loans for a house deposit - although most won't.
Those more flexible mortgage lenders willing to look at a deposit made up of borrowed money often add caveats. This might be, for example, only being able to use a loan for part of a house deposit, not all of it. Others may be more comfortable with business loans as deposits - especially for buy-to-let purchase, where this is more common.
Those lenders willing to accept a loan as a mortgage deposit are unlikely to offer you the best terms or interest rates, however. The entire cost of the house is covered by one form of loan or another in these circumstances - similar to a 100% mortgage. This makes you a high risk applicant!
You can typically take out a mortgage if you have an outstanding loan, depending on your debt to income ratio and credit score. Most lenders prefer a maximum debt to income ratio of around 50%.
This means that even those lenders happy to accept loans for a deposit on a mortgage, may still be difficult to meet affordability requirements for. As the size of loan needed for the majority of house deposits is significant, there's a strong possibility that it would push you over the lender's maximum debt to income ratio. This is even more probably if you have other debts as well, and if you have to borrow the whole amount.
Your credit file will always play a role in getting a mortgage, but if using a loan as a deposit, this will be even more important. When you're using a high percentage of the credit available to you, your credit score is affected. As credit referencing agencies award higher scores to those who stay within 50% of their available credit limit, both lenders and credit reference agencies may look at your level of borrowing as problematic.
A low credit score could limit how many mortgage lenders are willing to offer you a mortgage. If you have a history of missed, or even late payments, and are taking out both a large loan for a house deposit and an even larger mortgage, there will be concern about your ability to manage such high levels of debt.
James Jones, head of consumer affairs at Experian, explains: “Most mortgage lenders take a dim view of applicants raising a deposit using other forms of credit. We certainly advise people to avoid applying for credit in the run-up to a mortgage application.”
It's therefore always best to think creatively about how to get a deposit for a house rather than using loans. If you must use a loan, try and combine this with savings or a gifted deposit from family. You could also consider using a guarantor mortgage, which may mean you don't need a deposit at all.
Most mortgage lenders will prefer that you have at least 5%, however, not all lenders will be willing to lend at 95% LTV. The LTV (loan-to-value ratio) is the amount you borrow compared to the value of the propery you're buying. For example, if you needed to borrow £95,000 to buy a £100,000 house, your LTV would be 95%. The other 5% would be your deposit.
Most lenders offer a maximum LTV which is determined by your personal circumstances. Using a loan for a deposit may cause lenders to limit the LTV of their borrowing. A lower credit score, which you're more likely to have with a large loan, is another potentially limiting factor.
The interest rates offered to you will be higher, the higher your LTV. You'll, therefore, have access to more competitive interest rates with a large deposit.
It's a good idea to speak to a mortgage broker before taking out a loan for your house deposit. They can advise you on the likelihood of finding a willing lender under these circumstances.
They could also recommend other options for raising a deposit that you've not yet considered. Brokers deal with mortgage applications on a daily basis, so if there's another path to home ownership available to you, they're most likely to know about it.
Taking out a loan for a mortgage deposit is not ideal, but is possible if it's your only option. However, there are a range of other deposit types that you may want to consider, to avoid borrowing 100% of the cost of buying your home. It may also be cheaper to use 100% mortgage than to pay the interest on a personal loan for the deposit.
If you're fortunate to have a family member willing and able to give you a gifted deposit, make sure you can prove it's a gift, not a loan. Most people providing a gifted deposit will need to sign a declaration for the mortgage lender confirming that they won't seek repayment.
It's also important to be aware of inheritance tax law, as the person gifting the deposit must survive for seven years after giving it, if you want to avoid being potentially liable for inheritance tax.
If you're buying a new build property, the building company or housing group may provide incentives to help with your mortgage costs. This could be by reducing the cost of the property by the deposit amount, so you don't need one, or offering cashback.
Some lenders accept either form of vendor contribution as or towards your deposit, however, there may be a limit on how much of the property value they're willing to accept from this source.
Lenders may also cap the LTV if you use a vendor gifted deposit. So although it could be a useful contribution, you'd need to make up the remainder of the deposit another way.
Borrowing 100% of the money from a single lender, may be cheaper than borrowing the deposit from a personal loan provider and the mortgage from a mortgage lender. Essentially you're in the same position either way, as you don't strictly hold any equity in the property until you've repaid the deposit loan.
A guarantor mortgage or family assisted mortgage may make it possible to borrow 100% of what you need to borrow to buy the property. There is also currently one 100% product that doesn't require a guarantor of any kind.
A shared ownership arrangement is where you buy a percentage of a property with a deposit of a minimum of 5%. As you only need a deposit on a share of the property value (10-75%), rather than the entire value, a deposit should be much easier to achieve.
For a home valued at £200,000 - 5% deposit is £10,000
However, a 10% share is a £20,000 so - 5% deposit is £1,000
Although lenders advise against borrowing money for your deposit, there’s no shortage of ways to obtain the funds needed for a deposit if you can’t save enough:
Personal loan: You can take out a loan through a bank or building society for any reason. However, this will show up on your credit file, which a mortgage lender will check before deciding whether to grant you a mortgage and, if so, on what terms
Director’s loan: Many self-employed people operate through limited companies and pay themselves by taking small salaries from the business and the rest in dividends. In a good year, they may choose to leave the money in the business rather than take it all out and lose it through taxation. In this case, one option is for the company to lend money to the director, including a loan for a mortgage deposit, which would then be repaid from future dividends
Borrowing from family or friends: This option is far from straightforward. Again, your mortgage lender will want to know the source of the deposit. The problem with this type of loan is it’s not as strictly arranged as one organised through a financial company. Borrowing from family or friends can result in fractured relationships if either party becomes unhappy with the arrangement
Maxing out credit cards is an alternative to personal loans, although it’s not without its issues. The chances are, this will attract a high rate of interest, which could see your level of debt rocket in the long run, putting your mortgage repayments in jeopardy. It’s not ideal, but it may be an option if you're confident it will only be a short-term arrangement
There are of lots of ways you could potentially save more money towards a mortgage, here are some of the easiest:
Put aside a fixed amount every month using a standing order or autosave app. Take care not to overstretch, as you don’t want your good intentions to be cancelled out by overdraft charges
Cut out something you can do without. Even if it seems small, the cash can build up over time. Giving up smoking, takeaways, trips to the pub or coffee shop can all have an impact
Take a second job, even if it’s just one or two shifts a week at a bar or a gym
Flat share with a friend who’s also looking to save. Alternatively, search for flat-shares online via sites such as SpareRoom
Sell items you no longer need via auction sites. Old vinyl, books, toys and clothes are often easy to part with and in demand
Look at whether you have the best savings account, current account, and credit card rates, and switch if not. Likewise, don’t automatically renew your car and home contents insurance policies – shop around for better deals
If you’re eligible the Lifetime ISA helps those under 40 to save towards the cost of buying a home, and is topped up by the government
Theoretically, yes, as this would essentially be a gifted deposit in the eyes of most lenders. Your parents would need to repay the loan themselves, however, and sign a declaration to confirm its gift status and that you're not expected to make any repayments on the loan.
It's not an ideal situation, and it's a large amount of responsibility for your parents to take on, but if they are absolutely sure that the repayments will be affordable to them, it's certainly an option.
Yes, guarantor and family assisted mortgages both offer parents and loved ones a way to help you buy a house. This type of arrangement can enable you to take out a 100% mortgage, as your guarantor’s home or savings are used as collateral instead of a deposit.
There are risks involved for those acting as a guarantor or helping you meet affordability on a mortgage application, however, so ensure that they take independent financial advice.
Yes, some mortgage lenders allow you to use a director's loan as a deposit for a house, however, this is more commonly accepted in commercial borrowing.
There are lenders who will consider directors loans for residential home purchase, but they'll typically need evidence that the money has been drawn out of the business, and that the director has paid any relevant tax liabilities.