Assumable mortgage: What is it and how does it work?
Key takeaways
- When you assume a mortgage from a home seller, you become responsible for that loan at its existing interest rate and terms. The seller signs the balance over to you, while you compensate them for the amount they’ve already paid off.
- Most government-backed loans, such as FHA or VA loans, are assumable. Most conventional mortgages aren’t.
- An assumable mortgage can offer a better interest rate than what’s on the market today.
Used cars. Preowned furniture. Secondhand clothing. All of these can be smart, money-saving purchases. The same idea applies to homebuyers who take over, or “assume,” a seller’s mortgage, especially if it has a lower interest rate than what’s currently available. You can’t assume just any mortgage, however, and the process can be challenging. Here’s how it works.
What is an assumable mortgage?
An assumable mortgage allows a buyer to assume the interest rate, repayment period, current principal balance and other terms of the seller’s existing mortgage rather than get a brand-new loan.
The biggest potential advantage for the buyer is that the terms of the seller’s mortgage — especially the rate — might be more attractive than the terms available on a new mortgage.
What types of mortgage loans are assumable?
The main types of mortgages that can be assumed are FHA loans, VA loans and USDA loans:
- FHA loans: To assume an FHA mortgage, you’ll need to meet standard FHA loan requirements. These include having a credit score of at least 580 in most cases.
- VA loans: You don’t necessarily have to be a member of the military or a veteran to assume a VA loan, and if the loan originated before 1988, you don’t need permission from the VA or the lender to assume the mortgage. That said, if the loan originated after 1988, any loan assumption must be lender-approved. While the VA doesn’t require a minimum credit score, lenders typically look for a score of 620 and above. You’ll also still have to pay the VA funding fee.
- USDA loans: USDA loans are most often assumed with a new rate and terms. To assume a USDA loan, you typically need a minimum 640 credit score, among other eligibility requirements. However, in some cases, like transfers between families, they can be assumed with the same rate and terms without needing an income or credit review.
Are conventional mortgages assumable?
Most conventional mortgages — the most popular type of loan — are not assumable. They contain what’s called a due-on-sale or due-on-transfer clause, which mandates the mortgage be paid in full whenever the original borrower sells the property or transfers the loan.
That said, in special circumstances, you may be able to assume a conventional loan. To find out whether a mortgage is assumable, look for an assumption clause in your mortgage contract.
In most cases, the mortgage lender has to approve the assumption, and typically will hold the new borrower to the loan’s eligibility requirements.
Up until the 1980s, assumable mortgages were the norm. That changed in 1982 with the passage of the Garn-St. Germain Act, which allows lenders to enforce due-on-sale clauses if a property changed hands. Previously, state laws could block such actions. The legislation did specify exceptions to lenders being able to call a loan in, however — often in the case of death or divorce.
How do assumable mortgages work?
When you assume a mortgage, the current borrower signs the balance of their loan over to you, and you become responsible for the remaining payments. That means the mortgage will have the same terms the previous homeowner had, including the same interest rate and monthly payments.
You’ll still need to compensate the seller for the amount of the mortgage they’ve paid off. While this is part of the overall purchase price, you have to pay it right away — essentially as part of your down payment. The funds can come out of your own pocket, or you can finance the sum via another loan.
In addition, you’ll likely need to pay the lender an assumption fee.
Assuming a mortgage after death or divorce
Mortgage assumptions can happen outside of traditional real estate transactions. A family member (or sometimes even non-relatives) may be able to assume an existing mortgage on a home they’ve inherited. If one person is awarded sole ownership of a property in divorce proceedings, that person may be able to assume the full existing mortgage themselves.
In both cases, assumption is allowed even if the contract doesn’t include an assumption clause, or if it’s a conventional loan. In an inheritance scenario, the new borrower does not need to qualify for the loan if they were related to the deceased.
Pros and cons of assumable mortgages
Pros
- Buyers may get a lower interest rate. If rates were lower when the seller purchased the property, you may be able to assume a loan with a better rate than you’d get in the current market.
- Buyers may have fewer out-of-pocket costs. Although you’ll still pay fees, you may have lower costs than if you’d originated a loan — especially if the seller has a relatively low amount of equity.
- Sellers might attract more offers. If a mortgage is assumable and has a lower-than-market interest rate, the seller could draw more buyers and potentially command a higher sale price.
Cons
- Buyers can’t assume conventional mortgages, in most cases: While government-backed loans are assumable, conventional mortgages – the kind most homeowners have – typically are not. This makes assumable mortgages hard to find.
- Buyers still needs to qualify: Unless it’s a case of death, you must have the credit and finances to be eligible for the loan you want to assume.
- Buyers needs to pay sellers for their equity: While you’ll take over the seller’s mortgage and repay that over time, you’re only assuming their outstanding balance. You’ll still need to pay the seller the remaining cost of the home, either out of pocket or with another loan.
- Sellers might still be responsible for the debt: If the buyer doesn’t make payments and the lender hasn’t sufficiently released a seller from the debt, their credit could take a hit.
How much does it cost to assume a mortgage?
The costs associated with assuming a mortgage are often similar to the fees for taking out a new mortgage, but they can be less. They can include:
- Reimbursing the seller for their equity. This could amount to less than a traditional down payment, or it could be much more.
- An assumption fee. This is typically a percentage of the loan amount for conventional loans. For FHA loans, it’s capped at $1,800, and for VA loans, it’s a maximum of $300.
- Costs related to government-backed loans. For example, if you assume a VA loan, you must pay a funding fee. Assuming an FHA loan may mean taking on mortgage insurance premium (MIP) costs.
- Real estate transfer taxes. These may be paid by the person assuming the mortgage, depending on the state.
These costs might be worth it if the assumable loan comes with a lower interest rate than what you’d be able to get with a new mortgage.
How to assume a mortgage
To assume another borrower’s mortgage, take these steps:
- Confirm that the loan is assumable: You can verify this by carefully reviewing the loan agreement or asking the existing lender. The lender can also confirm that the loan is in good standing.
- Prepare for the costs: You’ll need to make a down payment, but the amount depends on how much equity the seller has. Once the assumption has been approved, you’ll also have to pay an assumption fee and potentially other costs.
- Submit your application: The process of assuming a mortgage could look different from lender to lender, but in general, you’ll need to fill out an application, provide proof of income and assets, and submit to a credit check.
- Close and sign liability release: If the assumption is approved, you’ll need to fill out paperwork just as you would when closing any other type of home loan. This might include signing a release of liability confirming that the seller is no longer responsible for the mortgage.
