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Personal loan or home loan: Which is right for me?

Peter Warden
The Mortgage Reports editor

Personal loan or home loan — Is that even a choice?

It never occurs to most people to pick between a personal loan or home loan when buying real property (aka a home). Why would it? Mortgages are almost always better by far.

But there are circumstances in which using a personal loan to buy a home may be your better — or only — way forward. Read on to discover when that’s the case.

Check my rate for a personal loan up to $100k * (Sep 16th, 2019)

*TheMortgageReports and/or our partners are currently unable to service the following states – MA, NV

Pros and cons of a home loan

A home loan (or mortgage, which is what one of those is) is designed for buying homes. The clue’s in the name.

Pros

And it’s usually far and away the best way to become a homeowner. Look at its three biggest advantages. You:

  1. Spread your borrowing over a long time, keeping each monthly payment low — The most popular type of mortgage is a 30-year one
  2. Get a low interest rate — Mortgage rates are the lowest rates most consumers will ever see
  3. May get tax breaks on your interest payments, something you won’t get with a personal loan. Consult a professional adviser before relying on those breaks

That provides unbeatably affordable borrowing.

Cons

Mortgages are “secured” loans. That means your home is security (or collateral; they mean the same thing) for your borrowing. And that brings two big drawbacks.

First, your contract gives your lender permission to repossess your home if you fall behind on payments or otherwise breach your loan agreement. In other words, you face foreclosure if things go wrong.

And secondly (and more importantly in this context), your lender needs to know it can easily sell your home if it has to foreclose. And it will ask your appraiser to assess just how readily marketable the property is.

Check my eligibility for a personal loan up to $100k * (Sep 16th, 2019)

*TheMortgageReports and/or our partners are currently unable to service the following states – MA, NV

Unmortgageable homes

This makes some categories of homes difficult or impossible to mortgage, simply because they’re likely to be hard to sell later. Those include:

  1. Tiny homes — Although increasingly popular, many lenders require bigger floor areas than these provide
  2. “Weird” constructions — log homes, homes with an earth roof or ones that are built in a dome shape can be hard to mortgage
  3. Falling down homes — Homes that are in advanced states of disrepair can be an issue for a mortgage lender. The same applies if they contain hazardous substances, such as lead paint or asbestos. However, you may have choices with a product such as an FHA 203K loan or a Freddie Mac CHOICERenovation one
  4. Inaccessible homes — Most lenders want to be sure you can reach the property year-round. And that you have established legal rights to access

This really does have more to do with marketability than lenders being obstructive. For example, if you want to buy a log cabin in the Montana mountains, you may well get a mortgage. If its ZIP code is 90210, you probably won’t.

Pros and cons of personal loans

This leads us neatly to a huge advantage that personal loans have. They’re unsecured.

Pros

  • Because they’re unsecured and not tied to a named asset, personal loans let you spend the money on anything. And that includes a 50-square foot, upside-down, dome-shaped cabin, made of asbestos logs and teetering atop an unclimbable mountain — if you want
  • If your loan ends up in trouble, your lender won’t have a direct route to seizing your assets. It will, however, come after you hard
  • You can borrow a lot. Most lenders cap personal loans at $50,000. But you can find ones up to $500,000 — and much more
  • Your total cost of borrowing can be lower — Borrowing over a shorter term (often five years) may be less costly than borrowing over decades, even if the interest rate is higher and you miss out on tax breaks
  • You’ll likely be debt-free sooner — personal loans typically last a shorter time than mortgages

How to buy a mobile/manufactured home with a personal loan

For homebuyers, personal loans have a lot going for them. But …

Cons

  • Personal loan lenders tend to charge higher rates — They have no asset to fall back on if you default
  • Your monthly payments will likely be high — You’re paying down over maybe 60 monthly installments (five years) instead of perhaps 360 (30 years)
  • You’ll probably need a decent credit score — Lenders focus on those and your household finances because they don’t have the cushion provided by collateral
  • Personal loans for people with bad credit are restrictive — You’ll be lucky to borrow a large sum for very long with one of these

How much those cons bother you will depend on your personal circumstances and needs.

Personal loan or home loan when buying residential real estate?

All those pros and cons should give you a good idea of whether you should use a personal loan or home loan when buying your next property. Nearly everyone’s going to be better off with a mortgage.

But there is a select group for whom a personal loan might be better. For example, suppose you’ve fallen in love with the idea of (unmortgageable) tiny homes.

If your credit’s good, your finances are healthy and your income’s sufficient, you could buy one now with a personal loan at a reasonable interest rate (roughly 5% and up). And you could have paid it off way before you would with most mortgages.

Check my rate for a personal loan up to $100k * (Sep 16th, 2019)

*TheMortgageReports and/or our partners are currently unable to service the following states – MA, NV