A personal loan is a form of credit, and both applying for and taking out a loan could impact your credit file.
As mortgage providers will assess your credit file at some point during the mortgage application process, a personal loan could have some kind of impact on getting a mortgage. Whether that impact is good or bad will depend on your personal situation.
That’s because a personal loan affects the amount of debt you have and may also impact how lenders view your creditworthiness.
You may find that having a manageable loan that you consistently repay on time demonstrates reliability, which could make it more likely for a mortgage lender to offer you a mortgage - potentially at a more competitive rate.
How personal loans impact mortgage applications
When assessing your mortgage application, lenders will look at how you’ve managed debt in the past, and your current levels of debt compared to the money you have coming in (your debt-to-income ratio).
Mortgage lenders prefer low-risk applicants (i.e. the applicants who are most likely to repay their debt on time) – and usually these applicants have lower amounts of existing debt that they repay, on time, consistently. That doesn’t mean that you can’t have a personal loan and successfully apply for a mortgage. It just means you need to be aware of how a loan can impact your application.
Your personal loan will be recorded on your credit file, which will be assessed as part of the lender’s decision-making process. Lenders will be able to see how you’ve handled your repayments. If you have consistently repaid your loan on time every month, this could demonstrate to the lender that you’re able to responsibly handle long-term debt. This may make it more likely that your mortgage application will be accepted, and you may even qualify for a more competitive rate.
You may also find that a personal loan adds to your credit mix and builds your credit history. Being able to show you’ve successfully managed debt in the past, in many cases, is far better than having no credit history at all. You can find out more in our guide on how to build credit history.
However, if you have a history of making late payments – or missing them altogether – this will be recorded on your credit file. Naturally, lenders may be more hesitant to offer you a mortgage at the best rates if you’ve been unreliable paying back what you owe in the past.
Lenders need to be confident you’ll be able to afford your mortgage repayments alongside any other credit commitments – including a personal loan. Mortgage lenders will look at your debt-to-income (DTI) ratio (what percentage of your monthly income is spent on repaying debt) to determine how much you may be able to borrow. If your DTI is low (ideally below 36%) your mortgage application is more likely to be accepted. Of course, a personal loan will play a part in your DTI and this could impact how much additional money you may be able to borrow.
How to minimise the impact of personal loans on mortgage applications
1. Make your repayments on time
Show prospective lenders you are likely to be a good customer by demonstrating a positive payment history.
2. Pay off as much of your debt as possible before applying for a mortgage
If your debt-to-income ratio is higher than you’d like it to be, consider paying off as much of your debt as possible before applying for any additional credit (including a mortgage). This could help you to improve your chances of being approved.
Always check for potential early repayment charges or fees to ensure settling your loan early is affordable for you.
3. Check your credit report
While there’s no such thing as a universal credit score – each lender will have their own scoring system – most lenders will use your credit report as part of your application assessment. It’s therefore a good idea to make sure you know what’s included on your credit file and ensure the information on there is accurate and up to date.
4. Limit the amount of credit you take out before applying
If you already have a personal loan, you may still be paying it off when you apply for a mortgage. Generally speaking, this may not affect your chances of success too much as long as your debt-to-income ratio remains lower than around 36% and you continually make your repayments on time.
However, do try to avoid applying for new credit if a mortgage application is on the cards. Remember that applying for any form of credit results in a hard credit check being recorded on your file, too, and multiple hard searches in a short space of time could raise concerns as it may indicate you’re struggling financially.
It's therefore sensible to wait for your mortgage application to be accepted and fully secured before applying for a loan to minimise the impact a temporary credit score hit could have on your application.
5. Research reorganising high-interest debt
Mortgage lenders will look at any and all debt, including high-interest credit cards. You may therefore find it beneficial to consider consolidating high-interest debts using a loan, though take care to ensure the interest rate on your loan is lower than the combined interest rate of your other debts if you’re aiming to bring your monthly repayments down.
While consolidation won’t reduce the amount of debt you have, you may find it more straightforward to manage just one debt repayment. This could help you to clear debt quicker which could improve your chances of being accepted for a mortgage.
Other mortgage FAQs
What are the key differences between a personal loan and a mortgage?
Personal loans are a type of unsecured loan, which means borrowers won’t need to put forward collateral to secure a loan. Borrowers apply for the funds they need and repay the money over a series of fixed-rate monthly instalments.
Mortgages, on the other hand, require borrowers to secure the loan against their home. This means that, should you fail to keep up with your repayments, a lender could repossess your home to recoup your debt.
You can usually borrow a smaller amount of money over a shorter timeframe using a personal loan, whereas mortgages may allow you to borrow a much larger amount of money and spread the repayments over several years. Whilst the interest rates on a secured loan such as a mortgage may be lower compared to a personal loan, you may end up paying more interest in total as you’ll be making repayments for longer.
Can I get a personal loan with a mortgage?
If you have already secured your mortgage but you have another significant expense on the horizon (such as paying for a car, a wedding or even some exciting home improvements for your new property), it may be possible for you to get an additional personal loan.
As discussed earlier, lenders assess your creditworthiness (the likelihood of you paying back what you owe) and your affordability (whether any additional credit may put strain on your finances) when deciding on an application.
If you are reliably repaying your mortgage each month, and an additional personal loan repayment is affordable for you, you may be able to get a personal loan if you already have a mortgage. Taking out a loan is a big financial decision and so should be considered extremely carefully.
Though there are no strict timescales, it may be best to wait between three and six months before applying for a loan if you have only recently secured a mortgage. This will give enough time for your repayment behaviour to be reflected on your credit report (and thus your credit score).
Can I pay off my mortgage with a personal loan?
Even if you are able to find a lender who would be prepared to lend you the money to pay off your mortgage (which is extremely unlikely), you could find yourself paying much more interest each month as personal loans tend to have higher interest rates compared to a mortgage. You will also need to consider any fees you’ll incur by paying off your mortgage early.
If your main priority is to pay off your mortgage sooner (perhaps to reduce the total amount of interest you need to pay), consider shopping around to find a mortgage lender that provides shorter-term mortgages instead.
Can I use a loan for a mortgage deposit?
If you don’t want to wait to save up for a deposit, it may seem like a good shortcut to simply borrow the money you need. However, most loan providers, including ourselves, will not allow you to take out a personal loan if you intend to use the money to pay off your mortgage or use it as a house deposit.
Furthermore, many mortgage providers will ask for proof of deposit funds and may reject your application if you’ve taken out a personal loan to fund your deposit.
That’s because lenders have a duty of care to all customers, and ensuring credit is affordable to customers is a key part of this. Taking out a loan and a mortgage concurrently will leave you with large debt repayments which you may struggle to comfortably afford (and will likely increase your debt-to-income ratio beyond a lender’s maximum limit).
Using a loan to fund a deposit essentially means you’ll be taking out a 100% mortgage and will have no equity on the property, which can be risky and could increase your chance of falling into negative equity (when your debt on the property is larger than its value).
Saving up for your deposit, using a gifted house deposit from friends or family, or looking into a guarantor mortgage may be more suitable options.
Can I add a personal loan to my mortgage?
While it is technically possible to consolidate debts into your mortgage by increasing the overall size of your mortgage, it’s something you should consider extremely carefully. For one thing, mortgages are a type of secured lending and so any debt will be secured against your home. Fail to keep up with your repayments, and your house could be repossessed by your lender.
While you may be able to reduce your monthly outgoings (because a secured loan like a mortgage may have a lower interest rate and a longer repayment term), you may actually end up paying more interest in total when you spread the cost over a longer period.
An alternative option could be to research debt consolidation loans, or to try and clear your debts over time instead.
Sophie Venner is a Yorkshire-based content writer specialising in crafting content for the financial services industry. She’s written over 300 articles on finance, but she’s covered everything from insurance to digital marketing trends. Her content has been featured in the likes of Semrush, Digital Marketing Magazine and Insurance Business. In her spare time, you won’t find Sophie far from a notepad and pen as she squirrels away trying to write a novel.
Wednesday 1st November 2023