Assumable Mortgage: What It Is and How It Works
When you want to buy a house, you’d ordinarily choose a lender and apply for a brand-new mortgage. But in cases where the house you’re eyeing has an assumable mortgage, you can acquire the house by taking over — “assuming” — that existing mortgage. In these cases, you’d take on the seller’s remaining mortgage balance.
What is an assumable mortgage?
An assumable mortgage allows someone to find a house they want to buy and take over the seller’s existing home loan without applying for a new mortgage. This means the remaining balance, mortgage interest rate, repayment period and other loan terms stay the same, but the responsibility for the debt is transferred to the buyer.
What it offers
When mortgage rates rise, there are always homebuyers who are at risk of being priced out of the real estate market. Right now, mortgage rates are the highest they’ve been since 2001 and still rising — a tough situation for many people dreaming of homeownership. Loan assumption can be a powerful enticement for these buyers as they shop for houses, because it would allow them to pay lower interest rates even as the housing market becomes more expensive.
How an assumable mortgage works
Mortgage assumption allows a buyer to take on the original loan balance at the original terms, but it’s important to note that it doesn’t account for equity. If the house has gained value since the original loan was issued, the buyer will need to cover that difference — also known as “home equity” — with cash or another loan.
For example, if the seller has a $200,000 loan balance on a $385,000 home, the buyer will need to bring $185,000 to the table to compensate the seller for the equity they’ve built.
A home equity loan is a common second mortgage option for buyers who are assuming a mortgage and don’t want to — or can’t — put cash down to cover the equity. Although this second loan will likely have a higher interest rate than the assumed mortgage, the principal amount will be far lower than what is needed for a “first” mortgage.
There are two types of mortgage assumption: simple assumption and novation. Both types have different implications for the ongoing relationship between the buyer, seller and lender.
- Simple assumption. In a simple assumption, the transfer of responsibility for the mortgage from seller to buyer is private. The mortgage lender isn’t privy to this transfer and therefore doesn’t put the buyer through the underwriting process. In practice, this means that if the buyer fails to make payments or otherwise breaches the mortgage contract with the lender, both the buyer and seller are liable.
- Novation. In novation, the mortgage lender participates in and agrees to the full transfer of liability from the seller to the buyer. Because the lender is able to put the buyer through the underwriting process, it is willing to release the seller from all future responsibility for the mortgage payments.
Which loans are allowed to be assumed?
Generally, government-backed loans — Federal Housing Administration (FHA) loans, U.S. Department of Veterans Affairs (VA) loans and U.S.Department of Agriculture (USDA) loans — are assumable, while conventional loans are only assumable in special cases.
Can conventional loans be assumed? The answer is: sometimes. In most cases, they aren’t assumable because the mortgage contract contains a due-on-sale clause, which allows the lender to demand you pay the entire remaining loan amount as soon as the property is sold.
However, if you have a conventional adjustable-rate mortgage (ARM) and meet certain financial qualifications, it’s possible that your mortgage is eligible for assumption. Fannie Mae — one of the two mortgage agencies that sets rules for conventional loans — allows for assumable ARMs so long as the borrower doesn’t exercise any option they may have to convert the loan to a fixed-rate mortgage.
All FHA loans are generally assumable, as long as the lender approves the sale. For loans originated on or after Dec. 15, 1989, the lender must approve a sale by assumption as long as the buyer is found to be creditworthy. Under special circumstances (such as death and inheritance), though, the lender isn’t entitled to check the creditworthiness of the buyer and doesn’t have to approve the sale.
All VA loans are assumable, but with additional rules and qualification requirements that govern exactly how:
→ Loans originated before March 1, 1988, are “freely assumable,” which means the assumption doesn’t have to be approved by anyone.
→ Loans originated after March 1, 1988, are assumable, as long as the lender approves and the buyer is deemed creditworthy and pays a processing fee.
Because VA loans are provided by the U.S. Department of Veterans Affairs, borrowers normally have to be active-duty service members, veterans or eligible surviving spouses to qualify for a VA loan. Note that in cases of assumption, however, the person assuming the loan isn’t required to be affiliated with the military.
USDA loans are assumable in two ways:
→ New rates and terms. Most USDA loans are assumable in this manner, which transfers responsibility for the mortgage debt to the buyer but also adjusts the debt by reamortizing it with new rates and terms.
→ Same rates and terms. Available only in special circumstances, this type of assumption is usually reserved for family members who are exchanging the title of a property. In these cases, the rates and terms of the original mortgage are preserved and no review of the buyer’s creditworthiness nor appraisal of the property itself is required.
Mortgage assumption after death and divorce
In order to be assumable, a mortgage contract usually has to contain a clause that allows for this special type of sale and gives the lender the right to look into the buyer’s financial situation. However, exceptions to this rule exist to protect people going through significant life events. After a death or divorce, for instance, mortgage assumption can help families transfer mortgaged assets even without the approval of the lender.
How to qualify for mortgage loan assumption
In order to qualify for a mortgage assumption, you first need to confirm that the house you want is eligible for assumption. Then, unless you’re buying the house from a family member, you should be prepared to meet the same minimum credit and income requirements that apply to typical, non-assumed mortgages. The table below lists the minimum requirements for the most common loan types:
|Conventional loan||FHA loan||VA loan||USDA loan|
|Minimum credit score||620||580 with 3.5% down; 500-579 with 10% down||No minimum, but 620 is lender standard||No minimum, but 640 is lender standard|
|Minimum DTI||45% back-end ratio||31% front-end ratio; |
43% back-end ratio
|41% back-end ratio||29% front-end ratio; |
41% back-end ratio
Pros and cons of an assumable mortgage
Mortgage assumption is an often-overlooked option that can make good financial sense, but before choosing any option you should always consider the benefits and risks.
Low interest rates. Since mortgage rates have risen so dramatically recently, assumption offers a rare chance to access lower rates as a buyer — or, if you’re the seller, boost the desirability of your house significantly.
Fewer closing costs. You’ll likely have lower closing costs, as certain closing costs on assumed mortgages are capped.
No appraisal. Typically there’s no appraisal required when transferring or selling through assumption.
Less debt. You’ll likely be able to take out a loan for a smaller amount than you would need with a non-assumed mortgage.
Higher down payment. If the seller’s equity is high, your down payment may be far higher than if you weren’t purchasing through assumption.
Credit and income requirements. Most sellers won’t agree to sell to you through assumption unless you meet the lender’s credit and income requirements because, in that case, the lender likely wouldn’t release them from continuing liability.
A note for VA borrowers. If you sell a house with a VA-backed mortgage through assumption, your VA loan entitlement won’t be available until the assumed loan is paid off, unless the buyer is a qualifying veteran with entitlement.
Potential fees. You may be required to pay loan assumption fees or ongoing mortgage insurance payments. The table below covers the type of costs you may have to pay under common loan assumption scenarios:
Mortgage insurance costs for loan assumption
|Loan type||Scenario||Insurance type||Length of time payments must continue|
|Conventional||Seller put less than 20% down||Private mortgage insurance of about $30 to $70 per month for every $100,000 borrowed||Until 20% equity is reached|
|FHA||Seller put less than 10% down||Mortgage insurance premium||Life of the loan|
|Seller put at least 10% down||Mortgage insurance premium||11 years|
|VA||Applies to all borrowers||Funding fee of 0.5% of the mortgage balance||One time, paid at closing|
|USDA||Applies to all borrowers||Guarantee fees of 0.35% of the mortgage balance||Life of the loan|