Assumable mortgages resurface when rates rise
By Michael D. Larson • Bankrate.com

When rates begin to rise, mortgage hunters look fondly at the lower rates that used to be available. In some cases, they still are.

By "assuming," or taking over, an existing low-rate mortgage rather than getting a new high-rate one, consumers can slash their monthly loan payments and save thousands of dollars in interest.

And while most conventional mortgages don't let sellers hand their loans off, many government-backed and specialized private ones do.

"If you have a house with a mortgage that is assumable, when you sell me that house, I am able to assume that mortgage and continue making payments on the mortgage," says Mike Gruley, president of First Financial Mortgage Corp., a Northville, Mich., mortgage brokerage. "It's one of the ways you can buy something and, if you aren't aware of it, you can miss it."

Ignored until rates start rising
Assumable mortgages have been around for years, but they don't get much play when interest rates are falling. After all, who wants to take over a 10 percent loan when 30-year mortgage rates average 6.5 percent? But when the situation reverses itself, old loans become prized by new buyers.

"Obviously, when the interest rate on the loan is lower than what the current interest rates are, it may well be to the benefit of the buyer to try to assume a loan," says Bob Finneran, assistant director for loan policy and valuation for the Department of Veterans Affairs.

So where do you start? First, realize that almost all standard loans have "due on sale" clauses, which require them to be paid off when the mortgaged house changes hands. That's because lenders got in serious financial trouble with assumables in the 1970s and 1980s due to soaring interest rates.

In short, they originated mortgages at 5 percent to 7 percent interest, then watched interest rates skyrocket to the point they were paying out 10 percent to 15 percent in interest on deposits. That gave buyers a strong incentive to assume the lower-rate loans, and sellers a hefty paycheck at closing for letting them. As a result, low-rate loans stayed on the books even after the homes securing them were sold, sticking banks in a no-win situation.

Most government loans are assumable
Because of the partial shift away from assumables, the lion's share of conventional loans originated in since then are off-limits. But Federal Housing Administration loans and VA mortgages supplied by the DVA, are fair game. An undeterminable number of large adjustable-rate mortgages and certain other unique loans are out there waiting to be assumed, too.

"The savings and loans crisis of the late '70s and early '80s caused almost all lenders to add a 'due on sale' clause to their mortgages," Gruley says. But "VA mortgages and some FHA mortgages are still assumable."

Buyers looking to take over one of them face a fairly easy process. They need to pass a government-mandated credit check and pay some fees for title transfer, recording and other closing steps. But that's essentially it, except for some minor restrictions. FHA requires a buyer to use the seller's property as a primary residence, for instance, unless certain hardship exemptions apply.

While the majority of assumable government loans are of the fixed-rate variety, many non-government ones are adjustable-rate mortgages. They don't provide buyers as much of a benefit as assumable fixed-rate loans for two reasons: One, their rates adjust with the market and two, they usually have a 1 percent transfer fee. But they do allow buyers to save money on their ARM margin, or the difference between whatever index an ARM rate adjusts to and the rate itself.

How? When demand for ARMs is low -- as it was in 1998 -- margins are usually smaller, says Roger Bentley Arnold, a loan officer with Community Mortgage Co. in Annandale, Va. Lenders might charge a rate equivalent to the yield on the 1-year U.S. Treasury Bill plus 2 percentage points, for example.

Now that higher interest rates overall have driven demand for ARMs up, however, the same loan might have a margin of as much as 2.75 percentage points. By assuming the older loan, a buyer locks in a lower spread, ensuring below-market payments no matter what happens to interest rates.

"On the adjustable side, you want to look at margin over index and how that compares to the margin on a new loan," Arnold says. "It's a classic situation, but it's counter to what people normally would think: The time to take an adjustable-rate product is when the fixed-rate products are at the lower level because margins will be the lowest. When 30-year fixed rates have already gone up, because the demand is there, the margins are ticked up by the lenders."

Assumability is a big selling point
If you decide to assume a loan, remember that sellers with cheap mortgages are offering something of significant value. That means they'll likely charge more for their houses and you'll have to come up with more cash to cover the difference between the asking price and the loan balance. At the same time, that assumability feature could increase in value if rates continue to climb, giving you the chance to cash out later.

"If we get into a 10 or 12 percent interest rate market, anybody that's selling their home and they have an 8 percent rate, what a great selling point that is," Gruley says.

Even without such an increase, though, an assumable loan is a powerful weapon that borrowers can use against escalating mortgage costs. Gruley recalls an $186,000 VA loan he did back in August 1998 at 7.5 percent. By assuming that 30-year loan rather than shopping for a new one, a prospective buyer could save about $100 a month.

"If it comes down to that's the house you want and it's all the same, yeah, $100 is better than a sharp stick in the eye," he says.