What is an Assumable Mortgage?
An assumable mortgage is one that a buyer of a home can take over from the seller – often with lender approval – usually with little to no change in terms, especially interest rate. The buyer agrees to make all future payments on the loan as if they took out the original loan.
There are advantages for both the buyer and the seller when processing an assumable mortgage, especially if the seller's mortgage interest rate is much lower than the current market rates, or is lower than the rate the buyer might be able to get based on credit history.
If current market rates are at, say, 6 percent, but the buyer can assume the mortgage at a 4 percent rate, the buyer has immediate savings.
There are also fewer closing costs involved when one assumes a mortgage. This means savings for the buyer, but can also be valuable to a seller. If the buyer has to come up with fewer dollars to close on the home and the buyer scores a better interest rate, then there is a greater chance that the seller can make a deal closer to the fair market asking price.
The seller also benefits from using this as a marketing strategy for the home, because not all mortgages are assumable, and it could give the seller an upper hand compared to other homes on the market.
A buyer who assumes a mortgage may have to take out a second mortgage, or come to the table with a hefty amount of cash, if the value of the home is greater than the mortgage that remains on the home.
For example, if the home is selling for $250,000 with a remaining mortgage of $100,000, then the buyer will need to come up with $150,000 to make up the difference. The buyer can do this by paying the rest in cash or take out a loan for the difference.
If the buyer has to take out another loan, this could complicate matters as the two mortgage lenders may not want to cooperate. If the buyer defaults on either loan this could become a legal headache for the other lender. It might also not be contractually allowed in some cases. Taking out another loan also greatly reduces the benefit of having an assumable loan.
Release From Liability
A problem for the seller could arise if the paperwork is not processed in a way that clears the seller from responsibility for the loan.
If a seller remains tied to the mortgage and the buyer defaults on the assumed loan, then the seller is likely responsible for the mortgage payments or whatever the lender cannot recover. To avoid this scenario, the seller should only participate in an assumable mortgage if the seller can obtain a release from the mortgage holder that will clear them of any liability.
There are parties who participate in unauthorized assumable mortgages, without involving the lender. In such cases, the seller simply invites someone to move in and start making the mortgage payments, or have the buyer pay the seller monthly as one might with a landlord, while the seller remains the owner and continues to pay the mortgage. Such cases are not technically assumable mortgages, and are usually a bad deal for a seller, especially if the mortgage does not qualify as an assumable mortgage or if it has a "due upon sale" clause, or if the mortgage would become due if the home is no longer the primary residence of the mortgage holder. The possibilities all depend upon what is outlined in the mortgage contract, which is a legal document.
FHA and VA Assumable Loans
Loans insured by the Federal Housing Administration and VA loans guaranteed by the U.S. Department of Veterans Affairs are assumable. However, certain conditions need to be met.
FHA loans closed before December 14, 1989, and VA loans closed before March 1, 1988, are assumable without conditions for the buyer. However, the seller of these loans can remain responsible for the mortgage if the buyer defaults on payments. It is not as likely that buyers will take on homes of this era as an assumable mortgage, mostly because many mortgages have been paid off already, or the amount remaining on the mortgage does not make it feasible. Mortgages remaining from the 1980s likely have double-digit interest rates that will not compare to the low rate one can get today.
For FHA and VA loans closed after the dates above, buyers will have to be approved by the lender, or the appropriate federal agency. For example, FHA has some stipulations on its loans, such as how long a person should have the home as their primary residence without facing penalty. FHA also stipulates that the home is occupied by homeowners of a certain income level, or that the buyer – even the assumable borrower – meets certain creditworthiness standards.
If a non-veteran assumes a VA loan, the original owner remains responsible for the loan in the event of bankruptcy or foreclosure. But if the new buyer is a veteran, they can transfer the VA status to the seller so that the seller can be cleared to purchase another home, using the VA status.
For newer FHA loans, a buyer looking to assume the loan must meet FHA standards. In some instances this is easy to do. Credit scores can be as low as 580, for example, for certain FHA programs. But typically FHA participating lenders want the score to be at least 620.
FHA may also deny the assumption if the buyer had a Chapter 7 bankruptcy filing within the past two years or a foreclosure in the past three years.