What is an assumable mortgage and how does it work?

Used cars. Pre-owned furniture. Secondhand clothing. All of these goods can be smart money-saving purchases. So, what about mortgages?

The idea might sound crazy, but in fact, a buyer can take over, or “assume,” a seller’s mortgage in some cases. The process isn’t easy, but both buyers and sellers should know how an assumable mortgage works, when it’s desirable and who it benefits the most.

What is an assumable mortgage?

An assumable mortgage allows a buyer to assume the rate, repayment period, current principal balance and other terms of the seller’s existing mortgage rather than obtain a brand-new loan.

The biggest potential advantage for the buyer is that the terms of the seller’s mortgage might be more attractive than the prevailing terms the buyer would be offered on a new mortgage. The interest rate is key, though other factors should be weighed, too.

Overall, assuming an existing mortgage can be simpler, easier and less costly for the buyer, says Lemar Wooley, a spokesperson for the U.S. Department of Housing and Urban Development.

What types of mortgage loans are assumable?

Most conventional mortgages — the ones offered by private lenders — 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 residence.

The sort of mortgages that can be assumed nowadays are generally government-backed or -insured loans.

FHA loans

If you want to assume an FHA loan, you’ll need to meet standard FHA loan requirements. These include being able to make a minimum down payment of 3.5 percent with a credit score of at least 580.

USDA loans

To assume a USDA loan, you typically need a minimum credit score of 620. You also have to meet income limits and location requirements. A USDA loan is typically assumed with a new rate and terms, but in some cases, like transfers between families, it can be assumed with the same rate and terms without needing to meet eligibility requirements.

VA loans

You don’t necessarily have to be a member of the military or a veteran to assume a VA loan, but the lender will evaluate your creditworthiness as a borrower. While there isn’t a minimum credit score, a lender will typically look for a score of 620 and above. You’ll also still have to pay the funding fee of 0.5 percent.

Conventional loans can be assumable in certain special circumstances (see “Assuming a mortgage after death or divorce,” below).

To know whether your mortgage is assumable, look for an assumption clause in your mortgage contract. This provision is what allows you to transfer your mortgage to someone else. In most cases, the mortgage lender has to approve the assumption, and typically will hold the new borrower to the loan’s eligibility requirements.

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.

And you will still have to come across with some cash at the closing.  If you assume the mortgage, you’ll need to compensate the seller for the equity they’ve built up in the home — 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 — as part of your down payment, basically. The funds can come out of your own pocket, or you can finance the sum via another loan.

For example, if someone owns a home valued at $400,000 with an outstanding mortgage balance of $250,000, that means they own $150,000 worth of the home outright. You’d need to make a cash payment of $150,000 to “repay” the seller for their equity stake.

Pros and cons of assumable mortgages

How to qualify for an assumable mortgage

In order for you to assume a mortgage, your lender has to first give you the green light. That means meeting the same requirements that you’d need to meet for a typical mortgage, such as having a good enough credit score and a low DTI ratio. Prepare documents such as proof of income and identification for the lender so they can determine if you’re a low-risk candidate for paying back the remaining mortgage.

How much it costs to assume a mortgage

The costs associated with assuming a mortgage are often similar to the fees for taking out a new mortgage. You may be responsible for real estate agent commissions, a down payment, closing costs and an inspection fee. Plus, you will be responsible for an assumption fee that is specific to this type of transaction.

Still, the costs are often worth it if the assumable mortgage comes with a lower interest rate than you’d be able to get with a new loan.

How to assume a mortgage

To assume another borrower’s mortgage, here are the steps to take:

1. Confirm that the loan is assumable – Ascertain that the loan is in fact assumable. It’s also a good idea to speak with the current mortgage holder’s lender to confirm first-hand they’ll allow the assumption and that the loan is in good standing: The borrower has been consistent and timely with their payments.
2. 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 closing costs, but these are generally lower when you assume a mortgage compared to getting one on your own.
3. Submit your application – The assumption process could look different from lender to lender, but in general, you’ll need to fill out an application form, provide proof of income and assets and submit to a credit check.
4. 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 a release of liability confirming that the seller is no longer responsible for the mortgage.

Assuming a mortgage after death or divorce

Assuming a mortgage doesn’t just have to happen through a sale, though. A family member (or sometimes even non-relatives) can assume an existing mortgage on a home they’ve inherited. Or if one person is awarded sole ownership of a property in divorce proceedings, that person can 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 in order to assume it, if they were related to the deceased.

Should you assume a mortgage?

If you love a home and can lock yourself into an existing mortgage with a competitive interest rate, assuming a mortgage may be a shrew move. It could save you time and effort in the short run and money in the long run.

But assuming a mortgage limits your choices (and you may not be a fan of the lender) and is not without complications of its own, particularly if it dramatically increases the down payment you have to contribute.

There may be better options. Consider going with a new FHA loan on a different home, which requires just a small down payment; certain conventional loans allow as little as 3.5 percent, 5 percent or 10 percent down, too.  You can also investigate down payment assistance programs that allow you to purchase a different property without having to hand over tons of cash at closing.

If high interest rates are the problem, consider buying mortgage points  to lower your rate. Or an adjustable-rate mortgage (ARM) offering a low, fixed rate for an introductory period. Always bear in mind that your mortgage can be refinanced later if interest rates drop.

Whatever you do, be sure to have a real estate attorney carefully look over any agreement or contract.

Additional reporting by Lara Vukelich