Homebuyers have more mortgage loan options available when buying a home than they may think.
One of those could be the assumable mortgage, a home loan alternative that enables buyers to essentially take over the home seller’s existing mortgage loan and avoid having to apply for a new mortgage that may come with higher interest rates.
While an assumable mortgage loan may be different than taking out a traditional home mortgage, it may offer benefits to select homebuyers—if they know how an assumable mortgage loan works and how to land the best deal possible.
Related: Understanding mortgage basics
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What are Assumable Mortgages?
Assuming a mortgage simply means that in a home sales transaction, the buyer takes over (or assumes) the existing mortgage loan held by the seller.
Under the terms of an assumable mortgage agreement, the buyer is responsible for the total amount of debt remaining on the seller’s existing mortgage. The buyer may also need to finance the amount of equity the seller has in the home.
Just as with any other financial agreement, it’s recommended that all parties know in advance what obligations they have when they agree to a mortgage assumption.
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What to Know Before Negotiating
For example, the buyer assumes the existing home seller’s mortgage, including the following components:
- The mortgage loan’s outstanding balance.
- The mortgage loan’s interest rate.
- The responsibility for making the loan payments for the entire repayment period.
US government-sponsored home mortgages , such as Federal Housing Administration, Veterans Administration, and Department of Agriculture home loans all allow assumable mortgages.
Home loans that operate outside of the federal government’s mortgage loan environment, such as conventional 30-year mortgages issued by a private lender, may not approve an assumable mortgage deal.
That’s why it’s advisable to check with the home seller and the mortgage lender to see if an assumable mortgage loan is an option before negotiating any deals.
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Why Do Assumable Mortgages Exist?
Actually landing an assumable debt is doable for both a buyer and seller, but the mortgage lending industry may not make it easy to cut a deal.
Why? Because as history attests, mortgage lenders may lose money on assumable mortgages.
In the late 1970s and early 1980s, when interest rates were at the highest levels in the past 50 years, assumable mortgage deals were attractive to buyers who could assume a seller’s mortgage at the original loan interest rate, which in many cases was lower than the then-current rate of a new mortgage loan.
According to data from ForecastChart.com, a seller with a mortgage originating in December, 1965, could count on an average mortgage rate of 5.45% as a basis for a new mortgage loan. Yet by December, 1980, the average mortgage rate stood at 14.79%.
By steering into an assumable loan in the late 1970s, the buyer could take over a home mortgage loan with significantly lower interest rates attached.
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Correspondingly, the seller could more easily transfer the property to buyers with an assumable loan if that loan came with a 5.5% interest rate instead of a rate two or three times higher, as new mortgages were at that time.
Mortgage companies, well versed in the field of interest rate mathematics, could see they were losing money if buyers chose a lower-rate assumable loan over a higher-rate new mortgage loan when buying a home.
That’s one reason why mortgage companies began inserting so-called “due-on-sale” clauses, which mandated full repayment of the loan for most US home transactions.
As the Federal Housing and Veterans Administrations began issuing more mortgage loans to US homebuyers, assumable loans grew in prominence again, as more relaxed rules allowed mortgage assumption home transactions as long as the homebuyer demonstrated the ability to repay the remaining home loan balance, usually after a thorough credit check.
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How Do Assumable Mortgages Work?
In an assumable mortgage, the homebuyer must make up the difference between the amount owed on the mortgage and the property’s current value. That could mean the buyer pays cash to make up the difference or takes out a second mortgage loan to cover the cost of the mortgage balance.
For example, a home seller has a $225,000 balance due on the home’s original mortgage on a property that’s valued at $350,000. Under the terms of most assumable mortgage loans, the homebuyer must deliver $125,000 at closing to cover the difference between the original mortgage loan on the home and the current estimated value of the home, which is usually determined by an appraisal on the property.
When agreeing to an assumable mortgage, the buyer and seller are usually working from one of two mortgage assumption models: a simple mortgage assumption or a novation-based mortgage assumption.
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Other Factors to Consider
In a typical simple mortgage assumption, the buyer and seller agree to engage in a private transaction. Under the terms of the agreement, the home seller transfers the title of the property to the buyer, after the buyer agrees to take over the buyer’s remaining mortgage payments.
If the buyer misses monthly payments or defaults on the original mortgage loan, the lender could hold both parties responsible for the debt, and the credit scores of both buyer and seller could be significantly damaged if the debt isn’t repaid.
Unlike a simple mortgage assumption, where a mortgage loan underwriter usually isn’t directly involved, a novation-based mortgage assumption is based upon the buyer agreeing to assume total responsibility for the existing mortgage debt and all the remaining mortgage payments on the original loan.
Under those terms, the original mortgage lender releases the home seller from the remaining mortgage loan debt.
No matter what form of assumable mortgage is in play, the deal can’t close without the permission of the financial institution that issued the original mortgage on the home.
Before that can occur, the homebuyer must apply for the assumable mortgage loan, and is vetted for creditworthiness and the ability to meet all the home mortgage lender’s contractual requirements—especially showing that they have the financial assets needed to qualify for the loan.
Once the mortgage lender signs off on the deal, the property title goes to the homebuyer, who starts making monthly mortgage payments to the lender.
In the event the mortgage lender denies the application for an assumable mortgage, the home seller must move on and find a qualified buyer.
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Pros and Cons of Assumable Mortgages
Like most financial vehicles, assumable mortgages have upsides and downsides. These factors may be at the top of each list:
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Upsides of an Assumable Mortgage
- Potential savings on rates. The homebuyer may save significant money on the home purchase if the original mortgage’s interest rate is lower than current mortgage interest rates.
- Closing costs curbed. The homebuyer might also save money on an assumable mortgage, as closing costs are minimized in private home sales transactions between a buyer and a seller. That may save the home seller thousands of dollars in closing fees.
- No appraisal needed. With no need to get a new mortgage on the property, a home appraisal isn’t required for a mortgage assumption transaction, although the buyer could request an appraisal as part of the general home purchase agreement.
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Downsides of an Assumable Mortgage
- More upfront cash required. To meet terms of an assumable mortgage, the buyer may need to have a substantial amount of up-front cash to close the deal. This usually occurs when the property’s value is greater than the amount remaining on the mortgage debt.
- Second mortgages can be problematic. Second mortgages aren’t always easy to obtain, as mortgage lenders may be reluctant to issue a second home loan when the original mortgage still has a balance due.
- The property may be in distress. In some cases, the home seller may be eager to get out of an expensive home, and may already be behind in making mortgage payments. In that event, the mortgage lender may require the mortgage to be made current (meaning getting up to date on payments) before it will approve an assumable mortgage.
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The Takeaway on Assumable Mortgages
Assumable mortgages might not be for everyone. They’re generally difficult to find and to close, and may require the buyer to take on the onerous task of qualifying for a second mortgage.
But if the buyer finds that assuming the mortgage will save money over getting a new mortgage (primarily through a lower loan interest rate), an assumable mortgage could be a good way to go.
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