July 23, 2009 in Mortgages

Homeowners facing foreclosure or a short sale may be able to save their credit rating if a new buyer assumes their loan. But this seemingly simple solution is fraught with potential problems.

In 2008, 620,000 consumers contacted the National Foundation for Credit Counseling about housing issues, triple the number of calls received in 2006. The number of homeowners in financial trouble has increased, but their options remain few.

One possibility is to find a buyer who will assume your loan if a traditional real estate transaction is unlikely. The downside to this may be losing your equity. The upside could be saving your credit and reaping the benefits of this next time around.

Assumable or not assumable?

Mortgage notes include a clause indicating whether or not the loan is assumable. If it is assumable, a third party may take ownership of the home, and the balance of the loan is transferred to them. The interest rate remains the same, and the lender may charge a fee for the transaction.

Loans backed by the Federal Housing Authority, or FHA, are often assumable, provided the loan is at least a few years old. Neil Viotto, a mortgage broker and executive vice president of Mortgage Express in Cedar Knolls, N.J., says that although most FHA loans were assumable in the past, this has changed with new loans in today’s economy and he hasn’t seen as many.

Assuming a VA loan has time constraints. According to the U.S. Department of Housing and Urban Development, VA loans that closed before March 1, 1988, may be assumed without approval from the VA or the lender. Applicants who wish to assume VA loans closed after March 1, 1988, must be approved by the Department of Veterans Affairs or its authorized agent.

Time may work in favor of homeowners with assumable loans who are seeking a buyer before they lose the property or have to settle for a short sale. “Banks are taking anywhere from three to four months to approve short sales, and foreclosures generally take about six months,” says Viotto. However, he warns that if the homeowner is behind on payments, a mortgage note may indicate that an assumable loan may not be assigned to a new buyer.

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An assumable loan cannot be transferred to a new homeowner without approval from the lender. “This is so that people with poor credit don’t end up with a mortgage that normally would not be approved,” says Stefanie N. Devery, from the Devery Law Group in Mineola, N.Y.

She adds that when a buyer is looking to assume someone else’s mortgage, it may be because they cannot qualify to purchase a home the traditional way and may not qualify for the assumption either.

Desperate measures

This was the situation that Ann Petersen confronted. Petersen couldn’t sell her Athens, Ga., house before a job transfer moved her out of state. As a result she was unable to purchase a new home and struggled to pay her new rent on top of her mortgage on the empty house. Six months after the move, her house was still on the market and she decided to rent it. The rent that Petersen received was less than the mortgage and she was financially slipping — fast. She warned her tenants that she may lose the house and would understand if they wanted to move.

“They expressed an interest in buying the home, but didn’t have a credit history and have been turned down for home loans in the past,” says Petersen.

Her loan was not assumable, but desperate times called for risky measures: She offered to transfer the deed to the renters if they paid her the full amount of the mortgage each month; she would in turn pay the bank.

“We hired an escrow company to do the transaction with the stipulation that if they were unable to get their own mortgage within three years, ownership would return to me.”

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The new owners secured their own mortgage two years later, which paid off the amount Petersen owed on the house, and her credit was saved.

Petersen was fortunate, and her outcome is more the exception than the rule. Not only was her loan not assumable, it had a due-on-sale clause, otherwise known as an acceleration, which means the bank can demand the balance of the loan. “If you sign the deed to the house over to someone else, the bank has the right to foreclose,” says Devery.

“It was scary,” says Petersen, “because I was afraid that the bank would find out and call in the note. I think that since they received their money every month, what we did either wasn’t noticed or wasn’t addressed.”

But not every third-party arrangement is on the up-and-up. Homeowners should be wary of anyone who offers to take over their mortgage payments if they sign over the deed to their house. “In the past two years there have been a high number of these scams, known as deed theft,” says Alyssa Katz, author of “Our Lot: How Real Estate Came to Own Us.” “The buyers get their own loan or cash out, then walk away, and the seller doesn’t realize what happened until it’s too late,” says Katz.

Installment plans

A less precarious way to sell your home to a buyer who will take over your payments is with an installment land sale contract, installment loan plan, lease option to buy or rent to own. The types of agreements and stipulations vary from state to state.

“With an installment land sale contract the seller keeps (the) title to the house and doesn’t transfer it to the buyer until the mortgage is paid off,” says Jerry F. Childs, attorney at law at Kahn, Soares & Conway in Hanford, Calif. The seller also continues to make their usual monthly payments to the mortgage company.

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It may sound simple, but Childs strongly recommends that homeowners seek competent advice by a professional eligible to practice in the state where the transaction will occur. “When something appears to be safe and a good idea, there should be an increased amount of concern,” Childs says. “Shortcuts are typically the most risky.”

He says that a few of the things sellers should be aware of include buyers who stop making payments and those who earn an equity interest in the house or have made improvements. The latter two could become a problem if the contract ends and the buyer will not be receiving the title.

Katz recommends that sellers find out if their loan stipulates that they must occupy the house and if the rental laws in their state have a cap on how long a rent-to-own type of agreement may last. The cap could be less than the life of the seller’s loan. Ideally, the buyers will apply for their own mortgage within a few years, and these types of arrangements can actually help them to qualify.

“A lot of banks ask for verification of rent from a landlord, if there is one,” says Devery, who explains how buyers and sellers can take this a step further. For example, if the mortgage payment is $1,500 but the buyers pay $2,000 per month with the extra $500 going toward a down payment on the house, it will show the bank that they can afford the mortgage and were able to save for a down payment too. This could increase their chances of qualifying for their own loan.

What’s in it for the buyer?

There are other reasons why a buyer may agree to assume someone else’s loan. The current interest rates may be higher than the seller’s loan. Or if the property appreciates, the buyer may earn equity if the sales price will be the balance of the loan or the home’s value at the time the papers are signed.

Rhonda Mannix and her husband saved almost 2 percent off the current interest rate when they assumed their seller’s FHA loan in Northfield, Minn., in 2005. “By the time we saved enough of a down payment to buy a house, we were priced out of the market and needed a bigger down payment in order to afford to buy. Saving on interest is what made homeownership possible for us,” says Mannix.

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