While assuming a mortgage may be different than taking out a traditional home loan, it may offer benefits to select homebuyers — if they know how an assumable mortgage loan works and how to land the best deal possible.
What Is an Assumable Mortgage?
Assuming a mortgage simply means that in a home sale transaction, the buyer takes over the existing mortgage held by the seller, including the loan’s outstanding balance, interest rate, and the responsibility for making payments for the entire loan term.
A buyer may also need to finance the amount of equity the seller has in the home.
Just as with any other financial agreement, it’s recommended that all parties know in advance what obligations they have when they agree to a mortgage assumption.
What Types of Loans Are Assumable?
Home loans that operate outside the federal government’s mortgage loan environment, such as conventional 30-year mortgages issued by private lenders, typically are not assumable.
The following kinds of mortgages, insured by the government and issued by private lenders, are assumable. A seller usually must obtain lender approval for the assumption, or in the case of USDA loans, agency approval. And the buyer must qualify.
The Federal Housing Administration insures these mortgages. With a minimum 3.5% down payment for borrowers with a credit score of 580 or higher, FHA loans are popular among first-time homebuyers.
Home loans guaranteed by the Department of Veterans Affairs are also assumable, and the buyer does not have to be a veteran or in the military. Note: The seller of these loans may remain responsible for the mortgage if the buyer defaults.
Loans guaranteed by the Department of Agriculture are assumable only if the current owner is up to date on payments.
How to Get an Assumable Mortgage Loan
First things first: Confirm that the loan is assumable.
The homebuyer must apply for the assumable mortgage and be vetted for creditworthiness and the ability to meet all the contractual requirements — especially showing that they have the financial assets needed to qualify for the loan.
The buyer will need to make up any difference between the amount owed and the home’s current value.
If the mortgage lender or agency signs off on the deal, the property title goes to the homebuyer, who starts making monthly mortgage payments to the lender. If the lender denies the application, the home seller must move on and find a qualified buyer.
Why Do Assumable Mortgages Exist?
Actually landing an assumable debt is doable for both a buyer and seller, but the mortgage lending industry may not make it easy to cut a deal. Why? Because as history attests, mortgage lenders may lose money on assumable mortgages.
In the late 1970s and early 1980s, when interest rates were at the highest levels in the past 50 years, assumable mortgage deals were attractive to buyers who could assume a seller’s mortgage at the original loan interest rate, which in many cases was lower than the then-current rate for a new mortgage.
According to data from ForecastChart.com, a mortgage originating in December 1965 had an average rate of 5.51%. Yet by December 1980, the average mortgage rate stood at 14.79%.
By steering into an assumable loan in the late 1970s, a buyer could take over a mortgage loan with a significantly lower interest rate attached.
Correspondingly, the seller could more easily transfer the property to buyers with an assumable loan if that loan came with a 5.5% interest rate instead of a rate two or three times higher.
Mortgage companies could see that they would lose money if homebuyers chose a lower-rate assumable loan over a higher-rate new mortgage loan.
That’s one reason mortgage companies began inserting “due on sale” clauses, which mandated full repayment of the loan for most home transactions.
As the FHA and VA began issuing more mortgage loans to homebuyers, assumable loans grew in prominence again. More relaxed rules allowed mortgage assumption transactions as long as the homebuyer demonstrated the ability to repay the remaining home loan balance, usually after a thorough credit check.
How Do Assumable Mortgages Work?
With an assumable mortgage, the homebuyer must make up any difference between the amount owed on the mortgage and the property’s current value. That could mean the buyer pays cash to make up the difference or takes out a second mortgage.
For example, a home seller has a $225,000 balance on the home’s original mortgage on a property that’s valued at $350,000. Under the terms of most assumable mortgage loans, the homebuyer must deliver $125,000 at closing to cover the difference between the original mortgage and the current estimated value of the home, usually determined by an appraisal.
When agreeing on an assumable mortgage, the buyer and seller are usually working from one of two models: a simple mortgage assumption or a novation-based mortgage assumption.
In a typical simple mortgage assumption, the buyer and seller agree to engage in a private transaction. The home seller transfers the title of the property to the buyer after the buyer agrees to take over the remaining mortgage payments.
If the buyer misses monthly payments or defaults on the original mortgage loan, the lender could hold both parties responsible for the debt, and the credit scores of both buyer and seller could be significantly damaged if the debt isn’t repaid.
Unlike a simple mortgage assumption, where a mortgage underwriter usually isn’t directly involved, an assumption with novation is based on the buyer agreeing to assume total responsibility for the existing mortgage debt and remaining payments.
Under those terms, the original mortgage lender releases the home seller from liability for the remaining mortgage loan debt.
Pros and Cons of Assumable Mortgages
Assumable mortgages have upsides and downsides.
Upsides of an Assumable Mortgage
• A lower rate may be possible. The buyer may save significant money on the loan if the original mortgage’s interest rate is lower than current rates.
• Closing costs are curbed. The buyer might also benefit because closing costs are minimized in private home sale transactions between a buyer and a seller.
• No appraisal is needed. With no need to get a new mortgage on the property, a home appraisal isn’t required for a mortgage assumption, although the buyer could request an appraisal as part of the general home purchase agreement.
Downsides of an Assumable Mortgage
• Upfront cash may be required. To meet terms of an assumable mortgage, the buyer may need to have a substantial amount of upfront cash or take out a second mortgage to close the deal. This usually occurs when the property’s value is greater than the mortgage balance.
• Second mortgages can be problematic. Second mortgages aren’t always easy to obtain, as mortgage lenders may be reluctant to issue a second home loan when the original mortgage still has a balance due. And a second mortgage probably carries closing costs.
• The property may be in distress. In some cases, the home seller may be eager to get out of an expensive home and may be behind on payments. In that event, the mortgage lender may require the mortgage to be made current (meaning getting up to date on payments) before it will approve an assumable mortgage.
• FHA loans carry an add-on. The mortgage insurance premium for FHA loans, if the home seller put less than 10% down, lasts for the entire loan term.
In a nutshell:
|Possibility of a lower interest rate than market rate||Buyer must make up difference if home value exceeds mortgage balance|
|Reduced closing costs||Home may be in distress|
|Home appraisal not necessary||FHA loans usually carry mortgage insurance premium|
Assumable home loans are generally difficult to find and to close, and may require the buyer to take on the onerous task of qualifying for a second mortgage. But if the buyer finds that assuming the mortgage will save money over getting a new mortgage (primarily through a lower rate), an assumable mortgage could be a good way to go.
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