Assumable Mortgage: What It Is and How It Works

When buying a house, you’d usually 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 take over — or “assume” — the existing loan, potentially benefiting from terms that are more favorable than ones you’d receive in the current market.

Think of it like stepping into the seller’s shoes: You’ll take their place as the person responsible for a loan that’s already partway paid off.

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Why choose an assumable mortgage?

With mortgage rates sitting at a relatively high 7.57% for 30-year loans, it’s a rough environment for homebuyers. Loan assumption, however, allows a buyer to take over the current owner’s mortgage while the loan’s terms — including the repayment period and interest rate — remain the same. Ultimately, it can help people get into a home at a lower interest rate even as the housing market around them becomes more expensive.

Additionally, sellers who can offer loan assumption may have a leg up on others because they can provide the opportunity to lock in low interest rates. In some cases, they can even sell their home at a higher price because the lower interest rate offsets the higher principal amount.

Are FHA loans assumable?

Most government-backed loans, including all FHA loans, are generally assumable, as long as the lender approves the sale. However, additional rules apply:

→  For loans originated on or after Dec. 15, 1989: If the buyer is creditworthy, the lender must approve a sale by assumption and transfer responsibility to the buyer. Loans issued before that date may be assumable, but the lender isn’t required to release the seller from liability.

→  Under special circumstances (such as death and inheritance): The lender isn’t entitled to check the buyer’s creditworthiness in cases of death or inheritance, and doesn’t have to approve the sale.

Are VA loans assumable?

All VA loans are assumable, but with additional rules and 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.

Who can assume a VA loan?

Yes, anyone can assume a VA loan, even if they haven’t served in the military. This is notable because borrowers usually have to be active-duty service members, veterans or eligible surviving spouses in order to qualify for a VA loan.

Are USDA loans assumable?

USDA loans are assumable in two ways:

→  With new rates and terms. Most USDA loans are assumable in this way, which transfers responsibility for the mortgage debt to the buyer at the same time as it adjusts the terms of the loan. When re-amortizing the debt with new rates and terms, the monthly payments and interest costs can change.

→  With the same rates and terms. Available only in special circumstances, this type of assumption is usually reserved for family members who are exchanging ownership of a property. In these cases, the original mortgage’s rates and terms are preserved. Neither a review of the buyer’s creditworthiness nor an appraisal of the property is required.

When are conventional loans assumable?

Conventional loans are rarely assumable, because the mortgage contract usually contains a due-on-sale clause, which allows the lender to demand the entire remaining loan amount as soon as the property is sold. That would mean that, as soon as the buyer assumed the loan, the lender could step in and hand them a bill for hundreds of thousands of dollars. Not many buyers want to take that risk.

However, if you have a conventional adjustable-rate mortgage (ARM), 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 as long as the borrower agrees to give up the option to convert the loan to a fixed-rate mortgage. Make sure your future plans don’t include converting to a fixed rate if you’re assuming an ARM.

In cases where a conventional ARM loan has been modified or deferred to help avoid default, it’s no longer eligible for assumption.

How the mortgage assumption process works

The safest type of assumption is novation, which is when the lender agrees to let the buyer take responsibility for the existing mortgage. Because the lender will put the buyer through the underwriting process before giving its approval, it is willing to release the seller from all future responsibility for the mortgage payments.

Simple assumption is a less-common way to assume a mortgage. It’s a private transfer of responsibility for the mortgage from the seller to the buyer without the mortgage lender’s approval. Because the mortgage lender isn’t involved and doesn’t put the buyer through the underwriting process, it’s a much riskier transaction. If the buyer fails to make payments or otherwise breaches the mortgage contract with the lender, both the buyer and seller are liable.

The catch: Accounting for equity

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 home equity the seller has built. If the house has gained value since the original loan was issued, the loan may no longer cover the home’s actual value and the buyer will have to make up the difference.

For example, if the seller has a $300,000 loan balance on a home they purchased for $435,000, the buyer will need to bring $135,000 to the table to compensate the seller for the equity they’ve built.

Can I take out a loan to cover the equity when assuming a loan?

Yes. 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.

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Steps to get an assumable mortgage

Once you’ve found a home you’re interested in buying, you’ll have to work with the homeowner and their lender to complete the assumption.

Here are the steps needed to assume a mortgage:

1. Track down homes for sale that have assumable mortgages

This is more of an art than a science, especially since most real estate websites don’t have filters to help you zero in on these homes. Below are some strategies you may want to try.

2. Use a title company

Ask a title company for title listings in the area that have government-backed loans. Since you know that most government-backed loans will be assumable, this will get you a preliminary list with names and addresses. You’ll then need to reach out directly to the homeowners to gauge their interest.

3. Scour MLS listings

Mortgage brokers can enter comments on the properties they list with a multiple listing service (MLS), and some may mention that the home comes with an assumable mortgage.

4. Target distressed properties

Homeowners who are in mortgage default may be more open to assumption, because it can help them avoid foreclosure. This route may take extra cash, as you’ll be required to bring the loan current by immediately making up for any missed payments or getting on a repayment plan.

5. Search the mortgage contract for an assumable clause

Look for language that clarifies the status of the mortgage. Even if there isn’t a specific clause that states the mortgage is assumable, it may still be. A real estate attorney can help you navigate the paperwork.

6. Provide documentation about your finances to the lender

Unless you’re assuming a mortgage privately from someone you already have a close relationship with, you’ll likely go through underwriting to transfer financial responsibility. The seller’s lender will put you through an approval process that requires documentation and information typical of a mortgage application.

7. Pay your closing costs and put down cash to cover the seller’s equity.

Closing costs on assumed government-backed loans are cheaper than the 2% to 6% you’d normally pay to close a loan. Each type of government loan has its own cap on how much you can pay in fees at closing, which keeps costs low.

8. Sign the promissory note.

Once you sign the promissory note, it’s official — you’re on the hook for the mortgage payments. If the lender has agreed to the assumption, they’ll also release the seller from all obligations related to the loan.

Death or divorce: How mortgage assumption can help

After a death or divorce, mortgage assumption can help families transfer assets even without the lender’s approval. You’ll get to skip the underwriting process, but you will still need to pay closing costs and cover any equity the previous owner had built. In a divorce, assumption can also help you remove one person’s name from the mortgage without refinancing.

Pros and cons of an assumable mortgage

Pros

  Lower interest rates. Since mortgage rates have recently skyrocketed, assumption offers a rare chance to access lower rates as a buyer — or, if you’re the seller, significantly boost buyer interest in your house.

  Lower closing costs. You’ll likely have lower closing costs, as certain costs on assumed mortgages are capped.

  No appraisal. Typically there’s no home appraisal required when transferring or selling through assumption. This can save you time and money.

  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.

Cons

  Higher down payment. If the seller has plenty of home equity, your down payment may be far higher than if you weren’t purchasing through assumption.

  Must meet 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, if you don’t, the lender likely wouldn’t release the seller from liability.

  No choice of lenders. When you assume a mortgage, you step into a relationship with the seller’s lender. You won’t get to shop around.

  Potential loss of VA entitlement. 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. That could be a long wait, so think carefully about how the sale could affect your future plans. However, there is an exception to this rule if the buyer is a qualifying veteran with their own entitlement.

  Mortgage insurance costs. You may be required to make ongoing mortgage insurance payments, which is an added cost on top of your principal and interest payments. Mortgage insurance isn’t unique to assumed mortgages, rather, it comes with all FHA loans and any conventional loan with a loan-to-value ratio higher than 80%.

Is an assumable mortgage right for you?

An assumable mortgage may be right for you if:

• You don’t want to purchase a home at current mortgage rates
• You have enough cash to cover a significant down payment or are willing to get a second mortgage
• You need a way to transfer property after divorce or a death in the family
• You don’t need to use a particular lender
• You’re a seller and want to make your home more desirable

Assuming a mortgage might be the wrong choice for you if:

• You’re looking for a low-down-payment option
• You want a fixed-rate conventional loan
• You don’t want a government-backed loan
• You can’t meet standard loan requirements and are planning to buy from someone who isn’t a family member or other close relation
• You’re looking to sell your home, but your current mortgage is a VA loan and you don’t want your VA entitlement tied to the home after it’s sold.