What is an assumable mortgage? True to its name, it’s a type of home loan where the buyer takes over the seller’s mortgage, rather than applying for a new loan. Assumable mortgages offer an array of advantages over traditional loans, but not all mortgages can be passed along in this manner. Here’s how to tell if an assumable mortgage is something you should consider, as a home buyer or seller.
What is an assumable mortgage?
Conventional loans are not eligible for assumption; they require the loan be paid in full—and a new one issued—whenever a property is sold or transferred to a new owner.
The three types of loans that are assumable include the following:
- FHA loans: These loans are backed by the Federal Housing Administration, which grants loans to low-income borrowers who might not quality for a conventional loan. Keep in mind that the new borrower, like the old, must qualify under all FHA terms, including credit and employment standards.
- USDA loans: These loans are offered or backed by the U.S. Department of Agriculture to low-income borrowers in rural areas. As above, the new buyer will need to meet the USDA’s credit score and income guidelines.
- VA loans: These loans, offered to active or retired military, can even be assumed by nonveterans.
Benefits for the buyer
Assumable mortgages can benefit buyers in numerous ways:
- A low interest rate: The key benefit to assuming a loan is snagging a lower interest rate than what is currently available. For instance, if the seller took out a 30-year fixed-rate loan of $200,000 at 4.2%, the monthly mortgage payment would total $978. If you were to borrow $200,000 at a slightly higher 5.2% rate, your monthly principal and interest payments would total $1,098. “Assumable loans are most logical in a rising rate environment, which this is becoming,” says Todd Huettner, founder of Huettner Capital in Denver.
- Fewer upfront costs: Since you aren’t getting a new loan, your costs for getting a mortgage will be greatly reduced. This can be a particular benefit if you’re assuming an FHA loan, since you won’t need to pay upfront mortgage insurance costs; you’ll just be responsible for the ongoing insurance payments for the life of the loan.
- A shorter loan life: Since the seller has already repaid the initial years of the loan, you would need only to make payments for the remaining years. So, if the original borrower was five years into a 30-year loan, the buyer assuming that would pay for the remaining 25 years.
- Long-term savings: This combo of a lower interest rate, fewer upfront costs, and a shorter loan life add up to major savings. You can calculate these savings with an online mortgage calculator.
Benefit for the seller
If you have a stellar mortgage, you can consider offering an assumable mortgage as a “pot sweetener” for potential buyers. Of course, if you’re in a seller’s market where properties are getting snapped up, there’s less incentive to make such concessions, but if you’re struggling to find a buyer, an assumable mortgage can definitely reel buyers in.
Reasons to not get an assumable mortgage
It sounds pretty enticing, doesn’t it? But before you run out to capitalize on someone else’s favorable loan, you should realize that even if the loan is eligible for assumption, that doesn’t mean it always makes sense. Here are three scenarios that make the assumable mortgage an unfavorable option:
- The assumable mortgage has a higher interest rate. This is a no-brainer. If the assumable mortgage has a 6% interest rate but the buyer can snag a loan for less, it’s better to get your own home loan.
- The home has appreciated significantly. If the home has risen in value by a long stretch, then assuming that loan won’t cover your costs. For instance, if the sellers bought the home for $200,000 but it’s now worth $250,000, you’ll need to pay the difference out of pocket. You can finance some of those additional costs with a second loan, but be aware that second mortgages are more difficult to qualify for and typically have a higher interest rate than a first mortgage.
- The seller needs his VA benefit. The VA benefit stays with the loan, not the person, which can make it challenging for the veteran to get another VA loan if he needs one after he moves on. The entitlement for each veteran is $36,000, which won’t go very far spread over two properties, but Huettner says this can work if a veteran’s old and new properties are very affordable or if he is planning to make a larger down payment on his new home and doesn’t need more of the benefit than what remains.
Assumable mortgages can make great sense in a variety of circumstances, despite their stringent guidelines. So consider talking to your lender about whether they might be a good choice for you.
Michele Lerner contributed to this article.
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