What is an Assumable Mortgage?

what is an assumable mortgage

As a homebuyer, we often consider a brand-new mortgage to finance our home purchases, and consequently, the home seller uses the proceeds to pay off their loan. However, in some cases, you can take on the sellers remaining mortgage debt instead of borrowing a new loan. Let’s explore how assumable mortgages work.

An assumable mortgage is a financing arrangement where an outstanding mortgage term and agreement are transferred from its original owner to a potential buyer.

The mortgage assumption isn’t as seamless as agreeing to take over a seller’s mortgage. Unless you’re assuming a loan from a close relative or an acquaintance, you generally must qualify for a mortgage assumption – once the home seller confirms they have an assumable loan.

The buyer needs to meet the same credit and income requirements applicable to a brand new loan. Thus, an assumable mortgage works much like a traditional home loan, except the buyer is limited to the seller’s lender.

It’s always a good idea to be on the lookout for deals. Knowing what assumable mortgages are and the process behind them may help you spot the next big bargain. It provides a potential buyer with the opportunity to purchase a new home by taking over the seller’s mortgage. One of the key reasons a buyer may contemplate an assumable mortgage is to take advantage of financing with lower market rates than the current market value.

 

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Understanding Assumable Mortgages

To qualify for an assumable mortgage, lenders will need to pass a credit score check and debt to income ratio to meet loan requirements. Additional information may include employment history, income information, and asset verification.

An assumable mortgage enables a homebuyer to assume the current principal balance, interest rate, repayment period, and any other contractual terms.

It’s necessary to have a minimum credit score of 580, though private lenders may have higher requirements. Your debt to ratio shouldn’t exceed 31% of housing expenses and 41% of total debts but there can be some flexibility depending on the loan type.  When a buyer is deemed creditworthy, mortgage investors need to approve the assumption. There could be several cost-saving alternatives when interest rates are higher than the ones on the assumable loan.

Buyers who acquire a mortgage assumption must meet rigorous requirements and receive approval from the agency sponsoring the mortgage.

Different Types of Assumable Mortgages

Don’t assume all mortgage loans are the same! In general, government-backed loans by the Federal Housing Administration, Veterans Affairs and the United States Department of Agriculture are assumable. However, each agency has specific requirements that both parties must fulfill to reach approval. In most cases, conventional mortgages aren’t assumable.

FHA Loans

Newer FHA loans require that both the buyer and seller meet specific requirements for an assumable mortgage. For example, sellers must live in their home as a primary residence with a minimum amount of time. Buyers must verify that the FHA loan is assumable and apply for an individual FHA loan. The good news for buyers is that FHA loans require a small down payment of 3.5%, making it an attractive option for first-time home buyers. They are also more accessible to less-than-perfect credit history!

VA loans

The Department of Veterans Affairs presents mortgages to military members, service members, and spouses. Most VA loans are assumable, but some exceptions don’t exist for others.

VA loans originated after March 1st, 1988, requiring approval before a lender allows an assumption. In addition, the buyer must meet credit and strict income qualifications. Depending on how the loan is originally settled, the lender may need the approval of the Regional VA loan center, which may add some valuable time to the paperwork process.

Loans originated before this date are freely assumable, meaning a homebuyer can assume the mortgage before the approval of the VA.

 

USDA loans

The United States Department of Agriculture credit advances are extended to buyers of select rural properties. A no-down-payment isn’t necessary and often has some of the lowest interest rates. The USDA allows mortgage assumption and has two types:” new rates and terms” and “same rates and terms.”

New rates and terms assumption enables the homebuyer to assume the seller’s outstanding balance, but the loan is re-amortized. A new interest rate and mortgage terms are chosen specifically for your financial standing. Most USDA loans fall into this category.

Same rates and term assumption enables the home buyer to assume the outstanding loan balance with the same interest rate and amortization schedule. This loan type is accessed in limited situations, including death and divorce.

In addition, the USDA requires the seller not to be delinquent on any payment, and the new prospective buyer must meet certain income and credit limits.

There’s a fee for assumable mortgages. For an FHA assumable mortgage is capped at $500, and the VA is $300. This fee doesn’t include any costs incurred by the lender during the transaction, such as a title search.

 

Pros and Cons of Assumable Mortgages

When you determine the pros and cons of taking over a new mortgage, consider any additional costs, paperwork, and allocated time frames to process the loan. While it may make sense to avoid high interest rates, it’s beneficial to shop around before committing to anything officially. Specialty mortgages can sometimes require additional approval terms or require higher down payments.

Several aspects of an assumable mortgage make them attractive to both sides of the real estate transaction. First, assumable mortgages have a significant marketing advantage. Second, possible low-interest rates and a simpler home buying experience make this loan option very attractive. Lower interest rates mean higher savings, potentially up to thousands. Third, banks often approve the mortgage loan more quickly, and settlement charges may be lower. Plus, buyers can save a few hundred dollars without an appraisal instead of paying for additional fees.

Buyers may not have high out-of-pocket costs when the seller’s equity is low.

If you’re the seller in this equation, an assumable mortgage might make sense for those who have difficulty attracting potential home buyers or a buyer who’s being priced out of the housing market. You may be able to get a better selling price for your home and have a different pool of potential buyers.

However, there comes caution with assumable mortgages. The grass isn’t always green; there are often increased risks involved. A mortgage that’s been assumed by a third party doesn’t mean the seller is relieved from debt repayment. If the new borrower defaults, the lender can come after the original borrower to get his money back and affect their credit rating. It can become increasingly problematic if the new borrower hasn’t taken care of the property and negatively impacted the resale value. To avoid this, the lender must approve a liability release. Your prospective home buyers will need to meet credit and income requirements to release the seller from liability on loan.

If you assume someone’s mortgage, you agree to take on their debt.

When the seller has a substantial amount of equity in their home, the buyer will either have to pay a sizeable down payment or secure a second mortgage for the balance not covered by the existing mortgage. If you’re financing the difference, you’ll need to find a lender who’s willing to qualify you for a second mortgage and ensure you’re still meeting your LTV radio guidelines. Lenders may not cooperate reasonably, and two loans increase the risk of default.

 

Why do sellers offer assumable mortgages?

House hunting is just like searching for treasure. Potential homebuyers must weigh an infinite number of factors to find the right one. An assumable mortgage lures buyers to a better mortgage deal that they could get otherwise.

In a market of rising interest rates, assumable mortgages are an incentive. If it’s a buyer’s market, you’ll be looking for those extras! Assumable mortgages are most common when available terms are less attractive than those given by the seller. The savings are substantial, and it doesn’t cost the seller a dime!

 

 

Sources

Cornell Law School Legal Information Institute (July 29, 2020). Assumable Mortgage
https://www.law.cornell.edu/wex/assumable_mortgage

Board of Governors of the Federal Reserve System (September 16, 2020). Federal Reserve issues FOMC statement
https://www.federalreserve.gov/newsevents/pressreleases/monetary20200916a.htm

Ross Garcia Forbes Councils Member (Mar 22, 2019). A Closer Look At Assumable Mortgage Misconceptions In Divorce
https://www.forbes.com/sites/forbesfinancecouncil/2019/03/22/a-closer-look-at-assumable-mortgage-misconceptions-in-divorce/?sh=4d16f8dd1649

Fannie Mae (December 16, 2020). B2-1.4-02, Adjustable-Rate Mortgages (ARMs)
https://selling-guide.fanniemae.com/

Contact the Cain mortgage Team to answer any of your Assumable mortgage questions.