Understanding What They Are and How To Use Them
Assuming a mortgage might be a possibility when buying a property, but it’s not always in the buyer’s best interest or allowed.
Understanding how an assumed loan works, what the mortgage lender requires, and what financial and legal considerations you have can help you decide if it’s the right choice for you.
What Is an Assumable Mortgage?
You may be wondering, “How does an assumable mortgage work?” An assumed mortgage is a mortgage a buyer can assume or take over from a seller, picking up where they left off instead of obtaining a new mortgage.
By assuming a mortgage, the buyer has the same rate and terms the seller had, including the remaining term of the loan, paying off the seller’s current principal balance.
For example, suppose Sally has a loan with a mortgage balance of $250,000 at 3%, and she sells her home to John. John could get a mortgage for $250,000 at 7%.
But he would be better off assuming Sally’s mortgage and taking over where she left off, as long as he has the funds to make up the difference between the loan amount and the agreed-upon purchase price.
How assumable mortgages differ from traditional mortgages
Assumable mortgages require lender approval, but only the seller’s lender can approve the buyer. Sellers cannot allow a buyer to assume a mortgage without the lender’s approval. If they do, they may be required to pay the full loan balance immediately.
However, like a traditional loan, buyers must go through underwriting to ensure they can afford the assumable mortgage. Lenders will ensure the buyer meets credit and income requirements for the loan, but typically don’t require an appraisal.
Types of Assumable Mortgages
Not all mortgage loans are assumable. Typically, it’s government-backed loans that buyers can assume. These loans traditionally have less stringent underwriting guidelines and more flexibility for homebuyers and homeowners.
FHA (Federal Housing Administration)
FHA loans are assumable, and the requirements for assuming them vary depending on the date the loan originated.
Any FHA loan originated before Dec. 1, 1986, has no requirements regarding assuming a mortgage. Buyers can automatically assume a seller’s mortgage without meeting any criteria.
FHA loans originated between Dec. 1, 1986, and 1989 are in a gray area, as Congressional action occurred in this time frame that makes most FHA loans assumable during that time.
FHA loans originated after Dec. 15, 1989, must meet specific requirements, including proving creditworthiness. Fortunately, the FHA loan guidelines are relaxed, allowing borrowers credit scores as low as 580 and a minimum 3.5% down payment.
VA (Veterans Affairs) assumable mortgages
VA loans are assumable and not just to veterans. These flexible, government-backed loans allow 100% financing and relaxed credit and income requirements pertaining to anyone applying for a VA loan.
Buyers may assume the principal balance if they meet the minimum requirements, proving they can afford the loan. Fortunately, the requirements are basic, since the VA doesn’t have required minimum credit scores or maximum debt-to-income ratios.
There’s one obstacle, though: If a veteran allows nonveterans to assume a VA loan, they don’t get their entitlement back.
For example, Jack, who is a veteran, bought a home for $150,000. He used his entitlement for the loan, which remains tied up until he pays the loan balance in full. Jack sells the home, but since the VA loan is an assumable loan, he allows a nonveteran to assume the original mortgage after the lender’s approval.
Jack’s entitlement remains tied to the home for the mortgage balance until the buyer pays the loan in full, either himself or by selling the home.
If Jack sold the home to a veteran with available entitlement, they could transfer the buyer’s entitlement to the loan, freeing up Jack’s entitlement to purchase another home.
USDA (United States Department of Agriculture) assumable mortgages
Most borrowers assuming a USDA loan do so with new mortgage rates and terms. The buyer assumes the outstanding assuming mortgage balance, but at reamortized rates and terms. Buyers may have a different rate and payment amount than the seller.
However, there are some exclusions. If the buyer who assumes the original home loan is related to the seller, they may keep the same rates and terms—for example, parents transferring a house to a child, ex-spouses exchanging property in a divorce, or transfer to a relative upon death.
In these situations, the rate and term do not change. The buyer picks up where the seller left off on the mortgage loan.
Are conventional loans assumable?
Typically, conventional loans, such as those backed by Fannie Mae, are not assumable. There are a couple of rare exceptions, but as a whole, no one can assume a conventional loan.
The exceptions include cases of transferring real estate due to death or divorce, or in some situations where a private lender doesn’t include a due-on-sale clause in the mortgage.
Pros and Cons of Assumable Mortgages
Like any financing decision, buyers and sellers should consider the pros and cons of a mortgage assumption. Here’s what to consider.
- Potentially lower interest rates: Buyers may secure lower mortgage rates by assuming a seller’s mortgage. This is especially beneficial in higher-interest rate markets. Sellers with lower interest rates can save buyers money.
- No appraisal: Lenders don’t require an appraisal, since sellers are transferring the property versus buying and selling it. This saves the buyer money on closing costs and the seller the hassle of scheduling and handling the appraisal process.
- Easier to sell: In a competitive market, an assumable mortgage may help sellers stand out, especially with rising interest rates. If buyers know they can secure a much lower interest rate than what’s currently offered, they may be more willing to purchase the home.
- No need to shop for a mortgage: Shopping for a mortgage can be more stressful than finding a property. Without the stress of finding the right lender, with the right rates and terms, buyers can focus on handling the purchase agreement and closing the sale.
- Large down payment: Buyers must make up the difference between the seller’s loan balance and the purchase price. This can result in a much larger down payment than a mortgage loan would require. For example, FHA loans require only 3.5% down, but a mortgage assumption usually requires a much higher down payment.
- Must meet lender requirements: While it’s beneficial not to shop around for lenders, buyers must fit the seller’s lender’s credit and income criteria. If the buyer has unique circumstances or doesn’t meet the criteria, the lender won’t release the seller of their liability.
- Can’t shop around: Some buyers prefer to shop around to find a lender with the best rates and terms. Not seeing options can make buyers wonder if they get a good deal.
How to Assume a Mortgage
If you’ve decided assuming a mortgage loan is right for you, here are the steps.
Determine if the seller has an assumable mortgage
Not all mortgages are assumable. The seller may know whether it is or not. If they don’t, read the loan agreement, looking for verbiage about assumptions or due-on-sale clauses.
Loans that don’t allow assumptions become due on sale immediately, which would warn buyers and sellers it’s not an assumable mortgage.
Apply for the assumption
If you determine the seller has an assumable mortgage, you must apply with the lender for the mortgage assumption for the existing mortgage balance.
This is similar to the process of applying for traditional financing. You’ll complete a loan application and provide information about your credit, income, assets, and debts.
Lenders will determine if you meet the credit and debt-to-income ratio requirements to take over the loan.
The process can take slightly longer than a traditional loan approval because the lender must release the seller’s liability for the debt and allow a new borrower to take over if approved.
Determine how you’ll make the down payment
The down payment on an assumable mortgage is different from a traditional mortgage.
Since you’re assuming the mortgage where the seller left off, there could be a good amount of equity the seller wants to recoup. The seller’s equity is the difference between the sales price and the loan balance.
Some sellers want the entire difference up front, requiring you to have a large down payment. Others allow you to pay them over time, or you may qualify for a second mortgage on the property to cover the down payment.
Sign the assumption agreement
The final step is to make the assumption legal. You’ll sign an assumption agreement that states you agree to the rates and terms of the loan and assume liability. The agreement also releases the seller from any legal liability for the debt.
The deed will be modified to register you as the new owner of the loan and property. This document gets recorded with the county.
Legal and Financial Considerations
It’s important to consider the legal and financial considerations of assuming a mortgage. Sellers are at most risk legally when dealing with mortgage assumptions.
For example, if a seller doesn’t ensure the lender approves the assumption, they could still be on the hook for the mortgage payments if the buyer doesn’t make them.
Some lenders will also make the entire loan due and payable immediately if they discover a seller transferred the loan to another party. Financially, both buyers and sellers take risks.
Buyers must ensure the mortgage is something they can afford and are comfortable paying without shopping around for another mortgage. Sellers must also be confident in the buyers’ approval, ensuring it is legit so they are not on the hook for the remaining loan balance.
Do You Need a Down Payment When Assuming a Mortgage?
The down payment is much different on an assumable mortgage than a traditional one. When buyers borrow a traditional loan, they can make the minimum allowed by the program, such as 3.5% for FHA loans.
With assumable loans, buyers must make up the difference between the agreed-upon sales price and the seller’s principal balance. Some sellers want the entire amount in cash at the closing.
Others are willing to allow seller financing, accepting annual, quarterly, or monthly payments to make up the difference. Some buyers may qualify for a second mortgage to cover the down payment.
Can You Transfer an Assumable Mortgage?
You can transfer an assumable mortgage only if the lender approves it. Sellers cannot randomly transfer their property to another party without approval.
This includes transfers to family members. If a property owner dies or gets a divorce, there are different rules regarding transferring an assumable mortgage.
Assumed Mortgages After Death or Divorce
If you inherit a property through death or divorce, you may automatically assume the mortgage in some cases.
It varies by lender, but the law typically allows the person who inherited the property to begin making payments on the existing loan. Before assuming this is the case, discuss the situation with a real estate lawyer to ensure you legally assume the mortgage and property.
Assuming a mortgage gives you more options when deciding how to finance a property.
Most government-backed loans have a clause for assumption, as do conventional loans in specific circumstances, such as death and divorce. Discussing your options with a real estate lawyer or financial professional can determine if an assumable mortgage is right for you.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.