Mortgage Assumability: Refinance Today to Sell Tomorrow

A mortgage assumption is a hidden feature built into FHA and VA financing. It may not seem important now, but when it comes time to sell, this little clause could produce big marketplace advantages.

With mortgage rates up sharply since May 2013 -- and with the possibility that they could rise higher -- the value of assumptions should not be underestimated. Properly used, an assumption can produce a faster home sale and better home price down the road.

It used to be that virtually all mortgages were freely assumable. The term "freely" meant that anyone could come along and take over your mortgage payments; that the lender could not prevent such an arrangement.

As you can imagine, mortgages that had been freely assumed sometimes went awry when the person taking over the loan couldn't make payments. That meant the original owner was still responsible for repaying the debt because the lender had not approved the assumption.

Then things began to change. After December 15, 1989 FHA loans stopped being freely assumable and so did VA mortgages originated after March 1, 1988. Today's VA and FHA loans can only be assumed by "qualified" borrowers.

Qualified assumptions are a good deal both for borrowers and lenders. The reason is that with a qualified assumption, the original borrower is no longer responsible for repaying the debt. For the lender, a qualified assumption is attractive because it reduces risk. The lender must okay the new borrower before the loan can be assumed, and it will only allow an assumption when the borrower meets standard credit and income guidelines.

Mortgage Assumption Considerations

When looking at FHA and VA assumptions there are several points to consider:

First, it costs money to assume a mortgage, but it's usually less than it costs to originate a new loan. There is no set fee for assuming an FHA mortgage ; HUD merely requires that the lender set fees that are "reasonable" and "customary."

Assuming a VA mortgage is pretty cheap. The VA charges a .5 percent funding fee (which can be financed!) to insure the mortgage. The lender can collect a processing fee in advance, including a reasonable estimate for the cost of the credit report. The maximum fee the lender can charge for the assumption is the lesser of:

  • $300 plus the actual cost of a credit report for servicers with automatic authority;
  • $250 plus the actual cost of a credit report for servicers without automatic authority; or
  • Maximum allowed by state law.

The value of the assumable loan depends on its interest rate. The bigger the difference between it and market rates when you sell your home, the more valuable the assumable loan (and by extension, your house) is. A fixed-rate loan remains unchanged for its life, while an ARM has a variable rate and so it will probably be worth less. Assuming a fixed-rate loan can substantially reduce monthly costs if the loan rate is less than current interest levels, say 4.5 percent in a market where interest is at six percent. For those who are selling, the ability to offer below-market financing can be a big plus.

Third, the age of the assumable loan matters. With a fully-amortizing fixed-rate loan, each monthly payment includes some money for interest and some money for principal. The older the loan, the greater the percentage of the payment that's devoted to principal. That's a benefit.

Of course, the older the fixed-rate loan, the lower the balance. Buyers will need to look at the difference between the sale price and loan balance to see how much cash is needed to complete the transactions.

Fourth, there are special rules which apply to VA financing. VA loans are assumable, but it's best for the seller if the assumption is with another vet. Why? Because it becomes possible to substitute the entitlement of the new borrower for the entitlement of the first borrower. That means the original borrower may able to get a new VA loan for a replacement property.

One advantage that VA offers is that it's okay for investors to assume VA home loans. FHA requires the buyer to occupy the property.

Fifth, assumptions require lender approval. Period. Mortgage servicers are entitled to accelerate (call in) the loan if (when) they find out about an unauthorized assumption. That means the buyer would have to find a way to refinance immediately, probably at a higher rate and greater cost -- or possibly end up in foreclosure. And what happens to the seller if the buyer defaults? Without an authorized assumption, the seller is still on the hook for the loan balance. It's just not worth risking.

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