What to know about assumable mortgages
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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?
In theory, any type of home loan could be assumable. But currently only three types of loans typically have this feature:
- 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. Note that 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 –The lender has to approve the assumption of a VA loan, usually by first evaluating your creditworthiness as a borrower. You don’t necessarily have to be a member of the military or a veteran to assume a VA loan. 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 usually are not assumable — except 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. Remember that if assumption is allowed, the mortgage lender will typically 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.
There’s also a wrinkle with the home purchase. 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 at the closing — as part of your down payment, basically. The funds can come out of your own pocket, or you can finance the sum by using 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 come up with a cash payment of $150,000 to “repay” the seller for their equity stake.
Pros and cons of assumable mortgages
- (Sellers) Your home can be more desirable – If your existing mortgage has a lower-than-market interest rate, it can be a selling point with buyers — especially if you haven’t built up much equity in the home.
- (Buyers) You typically don’t need an appraisal – A home appraisal isn’t usually required when assuming a mortgage, which might make the deal easier to close and saves the buyer an expense of several hundred dollars. (As a buyer, you might still want to get an appraisal independently of the lender to mitigate the risk of overpaying for the property, however.)
- (Buyers) No need to mortgage shop — Buyers don’t have to seek out lenders, compare rates, etc. Even if they need financing to pay back the seller’s equity, it’s likely to be a smaller or easier-to-qualify-for loan.
- (Buyers) You’re limited to the current lender – If you’d like to assume a mortgage, you must still apply for the loan and meet all of the lender’s requirements. Without the lender’s consent, the assumption cannot happen. That restriction limits your choice of a lender.
- (Buyers) You could need a lot of cash – If the seller has a lot of home equity, you could have to come up with a hefty down payment.
- (Sellers) You could still be responsible for the debt – If the buyer doesn’t make payments, the seller could potentially be negatively affected. “If the lender doesn’t release the original borrower from liability for the mortgage, and the assumptor defaults, then the original borrower suffers damage to his or her credit rating,” Wooley says. And could even be on the hook for payments.
How to assume a 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.
If you meet those requirements, here are the steps to take:
- Confirm that the loan is assumable – Be sure to confirm that the loan is in fact assumable. It’s also a good idea to speak with the current mortgage holder’s lender to ensure they’ll allow the assumption and that the borrower has been consistent with their loan payments.
- 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.
- Submit your application – The assumption process could look different from lender to lender, but in general, you’ll need to fill out an application and other forms and provide identification.
- 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.
Bottom line on assumable mortgages
Assumable mortgages aren’t particularly common, but they are out there and can be a good way for someone who needs financing to buy a home. If you find yourself with the opportunity to buy a home with an assumable mortgage, it could save you time and effort in the short run and money in the long run — especially if the existing mortgage has a competitive interest rate.
But assuming a mortgage limits your choices and is not without complications of its own, particularly if it dramatically increases the down payment you have to contribute. So think carefully, and be sure to have a real estate attorney carefully look over any agreement or contract.
Additional reporting by T. J. Porter