Assumable Mortgage: Pros and Cons for Buyers and Sellers

Assumable Mortgage: Pros and Cons for Buyers and Sellers

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An assumable mortgage allows a home buyer to not only move into the seller’s former house but to step into the seller’s loan, too.

Having an assumable loan might give a seller a marketing edge, particularly if mortgage rates have risen since the seller got the loan.

For a buyer, assuming a mortgage can save thousands of dollars in interest payments and closing costs — but it could require making a big down payment.

Here’s how assumable mortgages work, and the advantages and disadvantages for buyers and sellers.

What is an assumable mortgage?

An assumable mortgage is a home loan that can be transferred from the original borrower to the subsequent homeowner. The interest rate stays the same. So does the term: For example, if a 30-year mortgage is 3 years old, the person assuming the loan has 27 years to pay it off.

You, as the buyer, are stepping into the seller’s mortgage.

Michael G. Barone, managing partner, Abrams Garfinkel Margolis Bergson

“In an assumption, you, as the buyer, are stepping into the seller’s mortgage as if you had it right in front of you and you crossed out the name of the seller on the document and you inserted the name of the borrower on there,” says Michael G. Barone, a managing partner of mortgage compliance practice for law firm Abrams Garfinkel Margolis Bergson in New York City.

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Which mortgages are assumable?

Not all mortgages are assumable in a home sale. Buyers can assume federally guaranteed or insured mortgages, but not other types of home loans. That means:

  • FHA loans, which are insured by the Federal Housing Administration, are assumable.
  • VA loans, which are guaranteed by the Department of Veterans Affairs, are assumable, and the buyer does not have to be a veteran or in the military.
  • USDA loans, which are guaranteed by the Department of Agriculture, are assumable.
  • Other loans, called conventional mortgages, generally are not assumable in a home sale.
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Advantages of assumable loans

For sellers

Easier sale: An assumable loan can make the home more marketable if interest rates have risen in the years since the mortgage was originated. Imagine a situation in which someone gets an assumable mortgage with a 4.75% interest rate and then sells the house five years later when interest rates are around 7%. That 4.75% rate, impossible to get otherwise, could tempt buyers to choose that house over another.

Higher price: Another advantage is an assumable mortgage endows the seller with negotiating power on price. A smart seller weaves the assumable loan into the sales pitch “on Day One, so that’s a part of the negotiation right away,” Barone says. “So you’re going to have to pay us our asking price or a little more than our asking price.”

For buyers

Lower interest rate: An assumable loan summons a straightforward advantage for the home buyer, says Jim Sahnger, a mortgage originator for C2 Financial Corp. in Jupiter, Florida: “The pro is you’re getting whatever rate they have in effect.”

An assumable loan gives the seller negotiating power on price.

Lower closing costs: Also, it costs less to assume a loan than to get a new mortgage, lenders say. Mortgage closing costs usually total several thousand dollars. In contrast, the FHA, VA and USDA impose limits on assumption-related fees, making them more affordable than closing costs.

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Disadvantages of assumable loans

For sellers

VA entitlement: FHA and USDA loans have few, if any, disadvantages for sellers. But sellers who have VA loans can hit a snag when buyers assume their mortgages.

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With a VA loan, the government guarantees that it will repay part of the balance if the borrower defaults. The VA, which limits this guarantee, calls its dollar amount the borrower’s “entitlement.” Depending on the loan amount, some or all of the borrower’s entitlement remains tied up in the home with the assumed mortgage, even after the sale.

Because the entitlement remains with the assumed loan, the seller might not have enough entitlement remaining to qualify for another VA loan to buy the next home.

A seller can escape this predicament by selling to a veteran or member of the military who is eligible to get a VA loan. The buyer can then substitute his or her entitlement for the seller’s. In such a case, the VA restores the seller’s full entitlement.

For buyers

Large down payment: Rising home values can torpedo mortgage assumptions. To understand why, remember that when a buyer assumes a mortgage, it’s like stepping into the seller’s mortgage, which may no longer cover the cost of the house.

Rising home values can torpedo mortgage assumptions.

Let’s say a seller, after paying the mortgage for five years, owes $150,000 on it. The buyer would assume that amount. But the home’s value has risen to $215,000 in the five years that the seller has owned it. The buyer will have to pay the difference.

Subtract the loan’s outstanding balance ($150,000) from the home’s value ($215,000), and you get $65,000. The buyer has to come up with $65,000 to buy the home. In most cases, that means getting a second mortgage, “which usually has considerably higher interest rates,” Barone says. A second mortgage likely carries closing costs, further undermining the assumable loan’s advantage.

Because home price appreciation can snowball quickly, buyers have an easier time assuming mortgages that are just a few years old, he says.

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Mortgage insurance: FHA loans can present a drawback. Their monthly mortgage insurance payments last for the life of the loan and can be eliminated only by refinancing the loan. Those monthly payments negate some of the benefits of assuming the loan’s lower interest rate.

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How to assume a mortgage

Assuming a mortgage requires the lender’s approval. If a buyer and seller enter into an assumption informally, without telling the lender, they take a risk. After the lender finds out, it can demand payment of the full loan amount immediately. And if the loan stays in the seller’s name, the seller remains responsible for the debt.

In a properly done assumption, the new borrower must jump through some of the same hoops it would take to qualify for a new loan. The loan’s servicer requests the borrower’s credit report, plus financial and employment information.

“The lender still wants to make sure you can pay the loan, so they qualify you just as if you were a new buyer,” Barone says.

The lender won’t require an appraisal, Sahnger says.

Finally, the lender releases the original borrower’s liability for the debt.

Divorce, death and assumables

Not all mortgage assumptions arise from home sales. Sometimes one spouse assumes the loan following a divorce or the death of the other spouse.

In these cases, the person who assumes the loan must prove ability to make the monthly payments, says Randy Hopper, senior vice president of home lending for Navy Federal Credit Union. Approval isn’t automatic.

If the original loan note has both spouses on it, “then the lender likely qualified them for the loan on the basis of both of their incomes and both of their credit files,” Hopper says. “So if one of them is no longer on the loan, then we have to ensure that the remaining borrower is also qualified on their own.”

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