Advantages of an FHA Assumable Mortgage
FHA loans provide millions of homebuyers a path to homeownership each year, making up anywhere from 15%-20% of new purchase loans, according to the U.S. Department of Housing and Urban Development (HUD). FHA loans, which are guaranteed by the Federal Housing Administration, not only require a lower down payment (as low as 3.5%) but also provide loans to borrowers with credit scores as low as 500 and allow borrowers to use gifted funds as a down payment.
There’s an added benefit to FHA mortgages — one that is important both to homebuyers and sellers — that many people aren’t aware of: they are assumable.
What does it mean to have an FHA assumable mortgage? We’ll cover that and more in this post.
- Assumable mortgage basics
- The benefits of an FHA assumable mortgage
- Are all FHA loans assumable?
- Downsides of an assumable mortgage
- Assuming an FHA Loan
Assumable mortgage basics
An assumable mortgage allows you to take over where a current homeowner wants to leave off and assume their exact mortgage — repayment time and everything.
Once you’ve acquainted yourself with the pros and cons of assumable mortgages and decided to start looking for one, you can contact a local real estate agent who can look through listings for potential matches. In some cases, you may even have a friend or family member with an assumable FHA mortgage who is looking to sell.
The benefits of an FHA assumable mortgage
There are three major reasons why a potential buyer might be interested in assuming an FHA mortgage:
Taking advantage of a lower mortgage rate. When you take over an FHA assumable mortgage, you are assuming responsibility for the loan that the original homeowner was approved for. And while you may still need to be assessed for creditworthiness, your credit score will not prompt a change to the interest rate on the mortgage you are assuming. If you have a low credit score and you assume the mortgage of someone with a far higher score, it can save you a substantial amount in interest. In addition, today’s interest rates are slowly but steadily rising. While the current rate for 30-year fixed is still significantly lower than the rates we saw in 2006, there is a definite upward trend making certain loans issued between 2012 and 2017 more favorable. Assuming one of these loans means getting a lower rate from the past, regardless of the going rate on new loans.
Lower down payments. For buyers who are struggling to amass a 10% or 20% down payment, an assumable FHA mortgage can cut them a break. For an assumable mortgage down payment, buyers are generally expected to pay only the difference between the value of the property (the purchase price) and the balance on the loan. For example, if you were thinking about assuming a mortgage with a principal balance of $250,000 and you’re purchasing the home for its property value of $275,000, your down payment in this instance would simply be the difference between the loan’s remaining balance and the purchase price ($25,000).
No closing costs. Finally, because the buyer is assuming an already-closed loan, there are no closing costs to pay and they get all the benefits of an FHA loan without having to pay the FHA’s upfront mortgage insurance costs. Keep in mind, however, that you may still have a fee to pay the real estate agent as well as a mortgage assumption fee and title fee to the lender.
Of course, the buyer isn’t the only party who benefits from the assumable mortgage. For sellers, an assumable mortgage opens the door to many more buyers who otherwise might not be able to afford a loan at newer, higher interest rates. That can decrease the amount of time the house stays on the market.
Are all FHA loans assumable?
Yes, FHA loans are assumable, but there may be different requirements for assumption depending on when the loan was taken out.
There are three important timelines to consider when looking for assumable FHA loans:
- Loans taken before Dec. 1, 1986: There are no restrictions on who can assume the loan, meaning there is no need for the lender to approve the creditworthiness of the person assuming the mortgage.
- Loans taken between 1986 and 1989: These mortgage agreements may have language that restricts assumability, but thanks to Congressional action taken at a later date, they are assumable despite that language.
- Loans taken after Dec. 14, 1989: When assuming the mortgage of a loan taken on or after Dec. 15, 1989, the original lender must approve the creditworthiness of the assumptor, ensuring that they meet the (HUD) creditworthiness standards. These standards include having a credit score of at least 500.
Downsides of an assumable mortgage
Equity requirements. One of the first things to consider before taking control of an FHA assumable mortgage is whether you can afford to pay for the equity on the property — which will be the difference between the home’s sale price and loan balance. When you’re assuming a relatively young mortgage, the equity could be quite low, making the mortgage assumption very appealing. But on a home that’s had a mortgage for a while or one in an area with aggressive increases in value since the date of the loan, the equity could be much higher. In some instances, the buyer may even need to take out a separate loan to cover the equity, which will come with its own interest rate and may be aggressively rated if the buyer has a low credit score.
Making up missing payments. If the mortgage being assumed is in default, the buyer may need to make up those missing payments upon assuming the loan, which can increase their out-of-pocket costs.
No shopping for lenders. When assuming a loan, buyers must work with the lender who approved the original mortgage. If that lender doesn’t approve the new buyer, then the mortgage cannot be assumed. In addition, the buyer may be responsible for ongoing annual FHA mortgage insurance premiums, which could have been avoided with a non-FHA loan.
This raises a couple of important points and possible downsides for sellers with an FHA assumable mortgage. First, it’s that they can’t necessarily allow any would-be buyer to assume their mortgage, as the lender must approve them. Second, that they need to have the right paperwork completed by the lender to release them from potential liability should the buyer stop making payments. In some cases, sellers who allow another person or entity to assume a loan without approval may find that their mortgage is accelerated as a result, meaning they must pay the requested amount by a specified date, or face foreclosure.
Depending on whether you’re assuming the mortgage for a property meant to be your primary home or a second home or investment, you may need to reduce the outstanding balance to get a loan-to-value (LTV) ratio of 75% or 85%.
How to assume an FHA Loan
Whether you’re a buyer looking for an assumable mortgage or a seller with an FHA loan who wants to entertain the possibility of letting a buyer assume your existing loan, you probably want to find out what’s involved.
- Seller’s side: Your first step will be to approach your lender. There are several forms the lender must complete, some of which the seller will need to sign, including Form HUD 92210.1. This is an approval for the purchase of the home and a release of liability for the seller. Without this form, the seller will remain liable for the loan and be held responsible if payments stop.
- Buyer’s side: On the buyer’s side, the first step is to help the lender assess your creditworthiness. Like any mortgage approval, this may require various documents and information from you such as W-2s and tax ID. If the lender is in the FHA’s direct endorsement program, they can close the assumption without the FHA reviewing and signing off on it. If the lender is not in the program, they may contract approval out to a direct endorsement lender. An exception to this would be made for assumed loans originated before Dec. 1, 1986, as these do not have restrictions covering creditworthiness.
Assumable FHA loans offer a host of benefits to both buyers and sellers. While the financial benefits to buyers assuming a mortgage can be tremendous, it doesn’t mean that a mortgage assumption is the right choice for a buyer or seller. Buyers should consider the details of the loan, the benefits of securing their own loan, and their ability to pay off the property’s equity before stepping into a seller’s mortgage.
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