In this article:
- Why Would You Borrow Extra on a Mortgage?
- How Do You Borrow a Larger Mortgage Than You Need?
- Pros and Cons of Borrowing a Larger Mortgage to Pay for Something
For most homeowners, buying a new home involves taking out a mortgage loan that covers the home's purchase price minus your down payment. But what if you want to borrow extra money for other expenses?
It is possible to borrow additional money on your mortgage, but it may not be your best option. Taking out a larger mortgage than you need can help you cover upfront expenses such as moving costs, new furniture and home renovations. It may not be the best idea, however, especially when compared with other financing options. Here's why.
Why Would You Borrow Extra on a Mortgage?
There are several reasons why a borrower would take out a larger mortgage than they need to purchase a home. Here are some scenarios where a higher borrowing amount might be worth considering:
Pay for Home Repairs or Upgrades
Borrowing extra is a common way many homeowners fund major home repairs or renovations. Let's say you are financing the purchase of a home for $400,000; however, you want to upgrade the home with a $40,000 kitchen renovation and make $10,000 in other necessary repairs. If you're eligible for a larger home loan, you could add the $50,000 in expenses to your loan and take out a $450,000 mortgage loan.
If eligible, you can take out additional money through a higher conventional mortgage or a government-backed loan that allows you to borrow extra on your mortgage. For example, the Federal Housing Administration (FHA) offers an option called an FHA 203(k) loan that permits an additional $35,000 for home repairs that increase the value of your home.
Pay Off High-Interest Debt
Many borrowers take out a larger mortgage to pay off high-interest debt from credit cards or other loans. In this scenario, you may reduce the amount you pay monthly on your debt balances, although your monthly mortgage payment will rise with a higher borrowing amount.
Adding credit card debt to a 15- or 30-year mortgage may not make sense. Even if your mortgage has a lower interest rate than the debt accounts you pay off, you could pay more in interest over the life of the loan. Run the numbers before pursuing this path and consider faster debt repayment alternatives, such as a debt consolidation loan.
Furnish a New Home
If you're moving into a larger home and need to furnish it or cover other expenses, borrowing extra on your mortgage is one option. If you're purchasing a new home, it may come without features you might expect, such as window coverings, light fixtures or a landscaped yard. You may be required to address your yard by a specific deadline if your new neighborhood has a homeowners association.
In such situations, adding a little extra to your mortgage could come in handy. But when it comes to debt, it's wise to only finance what you need because you'll pay interest on the amount you borrow.
Pay for Moving Expenses
You may consider borrowing extra money on your mortgage to pay for moving expenses, especially if you're transporting your belongings a long distance. The average cost to move a two- or three-bedroom home out of state is around $4,890, according to data from Moving.com.
If your move requires several days, you could incur other move-related expenses like food, lodging and storage fees until you settle into your new home.
How Do You Borrow a Larger Mortgage Than You Need?
A larger mortgage loan could make meeting your lender's qualifications for a new home loan more challenging. Here are a couple of eligibility criteria to keep in mind:
- Debt-to-income ratio (DTI): This ratio compares how much you owe in monthly debt payments to how much you earn each month. When it comes to your DTI, lenders typically follow two general rules: Your DTI should be below 36%, and your monthly housing costs shouldn't exceed 28% of your gross income. You may be denied a larger loan amount if it boosts your housing-related expenses above that percentage.
- Down payment: Most lenders require a down payment on a home purchase, ranging from 3% to 20%. With a conventional loan, you should aim for a 20% down payment to avoid paying private mortgage insurance (PMI). Adding extra money to your mortgage could require you to make a larger down payment and make it harder to steer clear of PMI.
Even if your mortgage lender approves you for a larger amount, it's important only to borrow what you need since you must pay interest on your total loan amount. Before you take out a home loan, do your due diligence to ensure you can comfortably afford it, even if it means opting for modest renovations that fit within your budget. Consider only using extra loan money to pay for improvements that will add real value to your property.
Pros and Cons of Borrowing a Larger Mortgage to Pay for Something
You may qualify to borrow extra on your mortgage, but should you do it? Before you decide, consider the pros and cons of a larger home loan.
Pros of Borrowing Extra on a Mortgage
- Cover necessary expenses: The biggest benefit of borrowing extra money is that you can immediately pay for necessary home repairs, improvement projects or new furnishings.
- Consolidate your debts: Use the extra money to pay off high-interest credit cards, loans and other debts. Before you consider this option, make sure the amount you'll save outweighs the higher loan payment and interest charges that come with a higher loan amount.
- Potentially lower interest rates: In a low-interest-rate environment, you may score a lower interest rate on a mortgage than with other financing options.
- One monthly payment: If you are using the extra funds to consolidate debt payments or fund renovations, you'll only have to worry about making one monthly payment rather than multiple.
Cons of Borrowing Extra on a Mortgage
- Higher loan payments: With higher loan amounts come larger payments. For example, an extra $50,000 at 6% interest could add roughly $300 to your monthly payment.
- Larger down payment: Most lenders require a down payment of 3% to 20%. By increasing your loan amount, you may need to come up with a higher down payment.
- Interest paid over 15 to 30 years: An extra $50,000 could help pay for necessary home repairs or desired upgrades like a dream kitchen, but you'll pay interest on the funds. Repaying an extra $50,000 at 6% interest could cost you over $107,000 in principal and interest payments over 30 years.
- Alternative options may be better: According to the most recent Federal Reserve data, the average interest rate on a 24-month personal loan is 11.21%. While that's higher than Freddie Mac's reported 6.6% national average 30-year fixed-rate mortgage, a personal loan will likely save you money in interest charges due to its shorter repayment term. Most personal loan terms range from 12 to 60 months.
Good Credit Improves Your Financing Options
If you don't need the extra money right away, you might put off borrowing extra on your mortgage until you've built up equity in your home. At that time, you may qualify for a home equity loan or home equity line of credit (HELOC) or other options to finance home improvements.
Generally, your approval odds for a mortgage or other credit products improve with good credit. Lenders also tend to offer lower interest rates to those with strong credit profiles. As such, consider getting a free credit report and credit score from Experian to see where your credit stands. If necessary, take steps to improve your credit before applying for a new home loan.
