What is an Assumable Mortgage?CASAPLORERTrusted & Transparent
An assumable mortgage is a loan that can be transferred from the existing borrower to another one with the same terms and conditions. By assuming the mortgage of the seller, the buyer does not need to take out a whole new mortgage. However, they will still have to go through some of the same stages in the mortgage application, such as proving their creditworthiness.
What You Should Know
- An assumable mortgage is a loan that can be transferred from the original borrower to a new borrower, with the same mortgage rate, mortgage payment and other terms and conditions
- The new borrower still has to qualify for the loan in order to be able to assume it
- The new borrower will need to cover the difference between the house price and the remaining mortgage on their own
- While most FHA loans, VA loans and USDA loans are assumable, conventional loans are typically not
What is an Assumable Mortgage Loan?
Most homebuyers finance the purchase of their home by taking out a mortgage. This mortgage has set terms such as a given interest rate, term, a predetermined monthly payment that the homeowner will need to make and other terms and conditions. If the owner later decides to sell the house, they can either decide to use the proceeds from the sale to pay off their mortgage, or they can transfer their mortgage to the buyer.
This is the case with assumable mortgages. They allow one borrower to transfer their mortgage to another borrower. The new borrower will assume the mortgage with all of its previous terms. They will be charged the same interest rate, same monthly mortgage payment, same term and all the other conditions of the mortgage contract.
If there are rising interest rates and the homeowner has an assumable fixed-rate mortgage, then this may be beneficial for the new borrower, as they will get to pay a lower interest rate than what's currently available.
It is worth mentioning that as a new borrower, you would still have to be qualified for a loan. This way the lender can make sure that you are a creditworthy borrower who is financially capable to continue paying off the mortgage of the original borrower. Moreover, by taking over the mortgage of the seller, you are only assuming the remaining amount of the mortgage, which does not reflect the full price of the house. This means that you would have to cover the difference on your own.
How do assumable mortgages work?
The seller and the buyer need to first reach an agreement that the buyer will assume the seller's original mortgage. They would also need to decide on how much would the buyer have to pay the seller upfront on the amount of the mortgage that the seller has already paid off. This is typically the difference between the purchase price and the mortgage principal balance remaining. Once they have reached this agreement, they can contact the original lender and start the procedures of transferring the mortgage.
As mentioned earlier, the buyer would still need to qualify for the mortgage. This means that they must meet the credit score, income, and employment requirements to show the lender that they can afford the mortgage. The lender will look over the borrower's submitted documents and assess their financial situation to determine whether they will allow them to assume the original borrower's mortgage. Once they have been approved, the borrower will be able to continue paying off the mortgage with the exact terms as the seller.
Types of Assumption
There are two types of mortgage assumptions which differ from one another in terms of the role and responsibilities of the seller after the mortgage is assumed by the buyer.
Simple Assumption - With simple assumption, the buyer takes over the mortgage payments of the seller when they assume the mortgage. This is a more private transaction, where the lender is less involved. The seller transfers the title of the property to the buyer in return for the buyer taking over their mortgage and paying the difference. In this case, the seller is still responsible for the mortgage payments on the house. They act as a co-signer, who are liable for the mortgage. If the borrower misses any payments or shows any sign of delinquency, this will also be reflected on the seller's credit report. Therefore, a simple assumption presents a lot of risk to the seller of the house, which is why it is not typically used. Simple assumptions may be used only in situations of a family transaction. For example, transferring the mortgage to your son.
Novation - With novation, the buyer takes over the mortgage payments of the seller and all other responsibilities that come with assuming the mortgage. In this case, the seller is no longer liable for the mortgage payments to be made on time. They are released of all liability by the lender. Novation represents a full transfer of the mortgage from the seller to the buyer. This is more preferable by sellers since they wouldn't have to be tied to the mortgage until it is paid off completely. Novation is the most used type of assumption.
Which Mortgages are Assumable?
Not all mortgages are assumable. For instance, conventional mortgages are typically not assumable. They usually include a “due-on-sale” clause. The “due-on-sale” clause is a mortgage contract provision which requires the borrower to pay off the remaining principal balance on their loan when they sell the property. Most lenders and credit unions always include a “due-on-sale” clause on their conventional loans, but there may be some private lenders that don't include this clause as they face no legal obligation to do so. However, most of the mortgages offered by the Federal Housing Administration, the Department of Veterans Affairs and the U.S. Department of Agriculture, are assumable as long as certain conditions are met.
FHA loans given out after Dec 1, 1986 are assumable. However, the seller and the buyer must meet certain conditions in order for the loan to be assumed by the buyer. For the seller, they must have used the house as a primary residence for a certain number of years. The buyer, on the other hand, must apply and be qualified for the loan. FHA loans require borrowers to have a minimum credit score of 580 for a down payment of 3.5%, and a minimum score of 500 for a down payment of at least 10%. As per the Debt-to-Income ratio requirements, the DTI for household expenses should not exceed 31% and 41% for your total monthly expenses. Generally, FHA loans present less strict requirements for borrowers, which make them a more attractive alternative for first time homebuyers.
VA loans are loans available to military service members, veterans or their spouses and are backed by the Department of Veterans Affairs. These loans are backed with a guarantee, otherwise known as “entitlement”, which is a sum of $36,000 for each military service member or veteran. The department guarantees four times the entitlement amount which protects the lender if the borrower defaults on their mortgage. In order to assume a VA loan, a borrower must have the approval of the Department of Veterans Affairs and of the specific lender. If the loan is assumed, then the original VA borrower would get their “entitlement” back or their ability to buy another home through a VA loan. While the new borrower does not have to be a veteran or military service member, the seller will only receive their “entitlement” back if the buyer is one. VA loans made before March 1, 1988 are freely assumable. This means that the buyer does not need any type of approval in order to assume the mortgage of the seller.
USDA loans are available to individuals living in rural areas. Similar to FHA and VA loans, the buyer must meet the necessary qualification requirements in order to be able to assume a USDA loan. This means that they must have a credit score of 580 to 620 depending on the lender and their household income must not exceed 115% of the median household income in the area. The DTI ratio including only household expenses must not exceed 29% and the DTI including all monthly debt obligations must not exceed 41%. USDA loans require no down payment.
How to Assume a Mortgage?
The process of assuming a mortgage resembles the typical mortgage application process, however some steps are skipped, since the mortgage already exists. The process can be summarized in the following 4 steps:
- Make sure that the loan is assumable
The seller first needs to make sure that a mortgage assumption is permitted by the lender. To start off, the seller can check the loan documents and look for any clause related to mortgage assumption. For example, they might find an “assumption clause” or a “due on sale” clause. If these terms are not included, then the seller can directly contact the lender and ask them whether a mortgage assumption is possible.
- Request the lender for a mortgage assumption
The seller will need to request for a mortgage assumption. Both the lender and the government agency that backs up the loan will need to approve of the mortgage assumption. For example, if the seller has an FHA loan, the approval of both the lender and FHA will be needed. Typically, these services come at a cost. For FHA loans, a fee of $500 is charged. VA loans, on the other hand, charge $300 and a 0.5% funding fee which can be paid by either the seller or buyer. Besides these fees, the lender may also charge separate fees, usually ranging anywhere between $800 and $1000.
- Submit required documentation to qualify
Similar to the typical mortgage application, the lender will need to assess the creditworthiness of the new borrower. They must make sure that the borrower will have the financial means to pay off the mortgage. This means that the buyer must submit the necessary documentation related to their income, employment status, assets and debt obligations. They must meet the requirements set by the specific loan they are applying for.
- Sign the Assumption Agreement
The buyer and the seller will both be required to sign the final documents. The deed of trust is the document in which the borrower's name is added to the mortgage and the seller, who is the original borrower, is released of any obligations related to the mortgage. This happens in the case of a novation and not a simple assumption.
If you are the buyer assuming the mortgage, it may be a good idea to explore owner's title insurance, in order to protect yourself from any future claims on your property from third parties.
Pros and Cons of Assumable Mortgages
Before assuming the mortgage of the seller, it is a good idea to make an evaluation of the benefits and drawbacks that this option presents.
Lower Interest Rates - When taking over the mortgage of the seller, the buyer will face the same mortgage rate, term and mortgage payment as the original borrower. In an environment of rising interest rates, this is a great advantage to the buyer, since they will get a lower mortgage rate than what is currently available in the market. If they were to get a whole new mortgage, they would face higher rates.
Fewer Closing Costs - When a mortgage is assumed, another home appraisal is typically not needed, which translates into fewer closing costs. Moreover, FHA, VA and USDA place limits on closing costs when the mortgage is assumed.
Low down payment when equity is low - If the owner has not built a lot of equity in their home, then the difference the buyer will have to pay upfront is more affordable.
High down payment when equity is high - When the seller has built a lot of equity in their home, it means that most of their mortgage is already paid off. Thus, by assuming the mortgage the buyer would have to cover the difference between the home price and the remaining loan balance upfront.
Second mortgage - If the amount the buyer has to pay upfront is too large, then they might have to take out a second mortgage to cover the amount. This means that they would then have two monthly mortgage payments, pay two sets of closing costs and apply twice. This increases the chances of the borrower defaulting.
Lender approval needed - The lender may not approve of the buyer assuming the mortgage of the seller, if they need a second mortgage to cover the down payment amount.
When does it make sense to transfer a mortgage?
When the economic environment presents rising interest rates, then it makes sense for the buyer to assume a mortgage with a lower fixed rate. This way they will end up making lower monthly payments and pay less in interest than they would if they got a new mortgage. Buyers will be able to save in interest and possibly, even in closing costs.
A mortgage assumption would also make sense in a situation of a couple divorcing, gifts of real estate, estate planning or inheritances.
FAQ - Assumable Mortgage
Is a down payment required?
Typically, yes. The seller has built equity by making previous payments on the house, which are not included in the mortgage assumption. The buyer would typically need to pay for the difference between the home price and the remaining principal balance of the mortgage they are assuming, in order to compensate the seller for the full price. In some cases of recent VA or USDA loans, the buyer can negotiate with the seller to not make a down payment,
How do you qualify for a mortgage assumption?
A buyer would qualify for a mortgage assumption the same way as they would qualify by applying for a new mortgage. Depending on the specific loan and its criteria, the buyer will have to meet the necessary credit score, income and debt requirements.
How much does a mortgage assumption cost?
VA typically charges $300 and a 0.5% funding fee, that can be paid by the buyer or seller, for mortgage assumption. FHA, on the other hand, charges $500. However, the lender may also charge an assumption fee separately from the government departments.
Are there closing costs with assumable mortgages?
The closing costs for a mortgage assumption are usually the same as the closing costs for any other mortgage application. However, since a home appraisal may not be needed, the buyer may end up saving a few hundreds of dollars.
How do I know if my mortgage is assumable?
Government-backed loans such as FHA loans, VA loans and USDA loan are typically assumable. However, the approval of both the government department and the lender will be needed for the mortgage to be transferred. Conventional mortgages are not assumable since they often contain a “due on sale” clause. However, to make sure whether your mortgage is assumable or not, make sure to check your mortgage documents or contact the lender to ask them directly.
Is an assumable mortgage good?
If borrowers face rising interest rates, then an assumable mortgage with a lower fixed mortgage rate, is the preferred option. The borrower will also have to pay less in closing costs. However, if the seller has already paid off most of their mortgage and has built a considerable amount of equity in their home, the buyer will have to make a huge payment to cover the difference. In that case, the borrower might also have to take out a second mortgage.