What is an assumable mortgage, and how does it work?
Key Points
- A mortgage assumption means that the existing borrower co-signs the loan balance to you, and you are responsible for the remaining payments.
- Most conventional mortgages are not negotiable, but many government-backed loans (FHA, VA, USDA) are.
- The lender must approve your takeover of the mortgage, and you must repay the previous lender at closing.
Used cars. Pre-owned furniture. Second-hand clothes. All of these supplies can be intelligent, money-saving purchases. So what about mortgages? This idea may seem far-fetched, but in some cases, the buyer can take out or "assume" a mortgage from the seller. The process is challenging, but buyers and sellers should know how a secured mortgage works when needed and who benefits the most.
What is a hypothetical mortgage?
An adjustable-rate mortgage allows the buyer to take over the rate, payment term, current principal balance, and other terms of the seller's existing mortgage instead of taking out a new loan.
The most significant potential benefit to the buyer is that the terms of the seller's mortgage may be more attractive than those offered to the buyer in a new mortgage. The interest rate is essential, although other factors should also be weighed.
Overall, it could be more accessible, more affordable, and less expensive for a buyer to get a mortgage, says Lamar Woolley, a former spokesman for the U.S. Department of Housing and Urban Development.
How do mortgages work?
When you take out a mortgage, the existing borrower co-signs your loan balance, and you are responsible for the remaining payments. This means the mortgage will have the same terms as the previous homeowner, including the same interest rate and monthly payments.
You still have to come up with some cash at closing. If you assume the mortgage, you must compensate the seller for the home's equity—the mortgage you paid off. Although this is part of the total purchase price, you must pay it immediately as part of your down payment. Funds can come from your pocket or finance the money through another loan.
For example, if someone owns a home valued at $400,000 with a mortgage balance of $250,000, they hold $150,000 of the house. You must pay the seller $150,000 in cash to "pay off" his ownership interest.
Assume a mortgage after death or divorce.
However, a mortgage does not have to be by sale to assume. A family member (or sometimes a non-relative) can take out a current mortgage on their inherited home. Or if a person is awarded sole ownership of the property in a divorce proceeding, they can take full ownership of the existing mortgage.
In both cases, assumption is allowed even if the contract does not contain an assumption clause or if it is a conventional loan. In an inheritance scenario, the new borrower does not need to qualify for the loan to assume it if they are related to the deceased.
What types of mortgage loans are acceptable?
Most conventional mortgages (those offered by private lenders) are not acceptable. They contain a due sale or transfer clause, which requires the mortgage to be repaid in full whenever the original borrower sells the residence.
"By the 1980s, speculative mortgages were the norm. This changed in 1982 with the passage of Garn St. The German Act allows creditors to enforce due-on-sale clauses if a property changes hands (previously, state laws could prevent such actions). However, the law has defined exceptions, so creditors can often call on the loan in case of death or divorce."
However, in certain exceptional circumstances, conventional debts may be assumed. Consider an assumption clause in your agreement to determine if your mortgage is acceptable. This provision allows you to transfer your mortgage to another person. In most cases, the mortgage lender must approve the assumption and will usually require the new borrower to meet creditworthiness requirements.
The types of mortgages that can be taken out today are usually government-backed or insured loans, including:
- FHA Loans: You must meet standard FHA loan requirements for an FHA-qualified mortgage. These include a minimum payment of 3.5% with a credit score of at least 580.
- USDA Loans: To get a USDA loan, you generally need a minimum credit score 620. You must also meet income thresholds and location requirements. USDA loans are usually taken out at a new rate and terms, but in some cases, such as transfers between families, they can be taken out at the same rate and terms without meeting the eligibility requirements.
- VA Loans: You don't have to be a military member or veteran to get a VA loan, but the lender will check your creditworthiness as a borrower. Although there is no minimum credit score, a lender typically looks for a score of 620 or higher. You must also pay the VA funding fee.
Advantages and Disadvantages of Secured Mortgages
Consider that mortgages have their pros and cons before considering whether it's the right decision for you as a seller or buyer:
Seller's Advantages and Disadvantages
Pros
- Your home may be more desirable: If your current mortgage has a below-market interest rate, that could be a selling point to buyers, especially if you still need to build up much equity in the home.
- Faster loan repayment: If the buyer can qualify and assume the loan, the seller can get rid of their loan obligation much faster than in a traditional sale.
Cons
- You may still be responsible for the debt: If the buyer fails to pay, the seller may be negatively affected. "If the lender doesn't release the original borrower from the mortgage obligation and the assumption defaults, the original borrower's credit rating suffers," Woolley says. You may also be forced to make payments.
- Extended Processing Time: The mortgage approval process can take up to 90 days.
- Limited Pool of Qualified Buyers: Not all buyers are qualified or interested in borrowing from someone else. This limit can narrow the field of potential buyers, as the pool is limited to those who meet certain income and credit qualifications established by the lender.
Advantages and Disadvantages for the Buyer
Pros
- Your home may be more desirable: If your current mortgage has a below-market interest rate, that could be a selling point to buyers, especially if you still need to build up much equity in the home.
- Faster loan repayment: If the buyer can qualify and assume the loan, the seller can get rid of their loan obligation much faster than in a traditional sale.
Cons
- You may still be responsible for the debt: If the buyer fails to pay, the seller may be negatively affected. "If the lender doesn't release the original borrower from the mortgage obligation and the assumption defaults, the original borrower's credit rating suffers," Woolley says. You may also be forced to make payments.
- Extended Processing Time: The mortgage approval process can take up to 90 days.
- Limited Pool of Qualified Buyers: Not all buyers are qualified or interested in borrowing from someone else. This limit can narrow the field of potential buyers, as the pool is limited to those who meet certain income and credit qualifications established by the lender.
How to Qualify for a Mortgage
To get a mortgage, your lender must give you the green light. This means meeting the requirements for a typical mortgage, such as a reasonably good credit score and a low DTI ratio. Prepare documents such as proof of income and identification for the lender to determine if you are a low-risk candidate to pay off the mortgage balance.
How to get a Mortgage
To assume another borrower's mortgage, follow these steps:
- Verify that the loan is acceptable: Verify that the loan is OK. It's also a good idea to check with the lender of the current mortgage holder to confirm that they will allow the assumption and that the loan exists.
- Prepare for costs: You'll have to pay a down payment, but the amount depends on the seller's equity. After the assumption is approved, you'll also have to pay closing costs, which are usually lower when you take out a mortgage.
- Submit your application: The assumption process may vary from lender to lender. You'll still need to fill out an application, provide proof of income and assets, and submit to a credit check.
- Close and sign waivers: If the assumption is approved, you'll need to complete the paperwork just like you would when closing any other mortgage loan. This may include a disclaimer confirming that the seller is no longer responsible for the mortgage.
Frequently Asked Questions About Mortgages
How much does it cost to get a mortgage?
The costs associated with taking out a mortgage are generally similar to the fees for taking out a new mortgage. You may be responsible for the real estate agent's commission, down payment, closing costs, and inspection fees. In addition, you will be responsible for paying the assumption fees specific to these types of transactions. Still, the costs are often worth it if the interest rate on an acceptable mortgage is lower than what you could get with a new loan.
Should you get a mortgage?
It depends. Taking out a mortgage can be beneficial in certain situations, such as when the interest rate on the seller's original mortgage is currently available in the market or in markets with higher interest rates. However, getting a mortgage can be complicated and expensive, and not all buyers will qualify. Whatever you do, have a real estate attorney carefully review any contracts or agreements.
Before deciding to take out a mortgage, consider the following facts:
- The buyer must qualify based on credit score, income, and other criteria established by the lender.
- Only certain types of loans are acceptable.
- Additional mortgage handling costs may include assumption fees and mortgage insurance payments.
- The buyer must pay the seller for its equity up front, which may mean spending a sizeable down payment.
