When most people buy a house, they find a lender that will help them finance the purchase. The same is true of many real estate investors, who delight in the ability to leverage debt to build their rental empires. Primary homebuyers and investors alike, however, might be interested in learning how to assume a mortgage loan for a property.
Assuming a mortgage isn’t always possible, and even if it is, it might not always be desirable.
In some instances, though, there are some serious benefits to assuming an existing mortgage, including getting a lower interest rate and potentially paying less up front for the property.
What exactly is an assumable mortgage, and how can you get one? Let’s dive in to take a look at everything you need to know about assuming a home loan.
A buyer can assume the existing mortgage rather than getting a new home loan through an assumable mortgage. This means that the buyer will assume the terms of the mortgage from the seller, including the:
You might ask yourself why someone would choose to assume an existing mortgage rather than getting their own. The biggest potential win that a buyer receives from this arrangement is that they might lock down more appealing terms than they would be able to get by taking on a new mortgage.
It’s common for people to focus on the interest rate when considering assuming a mortgage. This is definitely an essential factor, but it’s important to take into consideration the other elements of the mortgage.
In instances where assuming a mortgage is possible and attractive to the buyer, it can be simpler and less costly.
Before you start working out how to assume the mortgage on your next property purchase, though, it’s important to know that there are some special considerations to incorporate into your decision-making process.
It’s quite common for homebuyers to take out a home loan to finance the purchase of their home. If you own rental property, there’s a good chance you’ve pursued a mortgage from a lending institution for this purpose, as well.
When a person takes out a mortgage, they are contractually obligated to repay the loan based on a number of terms. These include:
If the owner of the home chooses to put their house on the market down the road, they could be able to pass their mortgage on to the person that buys the property. The original mortgage is “assumable” if this is the case.
The person buying the property can assume a mortgage rather than going through the strenuous process of getting a brand new one from a lending institution.
If current interest rates are higher than the rate on the existing mortgage, this could save the buyer a lot of money in the long run. So long as the rates have been locked-in on the assumable mortgage, the buyer can avoid the sometimes drastic impact of increasing interest rates.
Let’s take a look at an example to help illustrate exactly how an assumable mortgage works.
One important note about assumable mortgages that you’ll want to take into account when considering them is that mortgage assumption doesn’t account for equity.
This means that if the property you are purchasing has increased in value since the loan was first taken out, you’ll be on the hook for the different. You can do this either through another loan or with cash.
Let’s say that the seller has a $250,000 loan balance on a home they are selling for $350,000. This means that the buyer will need to show up with an additional $100,000 in order to close on the purchase.
If you’re serious about considering assuming a mortgage, you’ll want to know about the two different types of mortgage assumptions. These are simple assumption and novation. The type of mortgage assumption you take on with imply different outcomes when it comes to the relationship between you, the seller, and the lending institution.
When you assume a mortgage through a simple assumption, the responsibility for the mortgage is transferred privately between the seller and the buyer. The buyer doesn’t have to go through the underwriting process because the lender isn’t involved in the exchange.
While this process is simpler, it could cause potential issues down the road. Basically, if the buyer doesn’t make their mortgage payments or otherwise breaks the loan agreement, the lender will hold both the buyer and the seller liable.
If you are thinking about passing on an existing mortgage to a buyer through this method, it’s essential that you understand that you are still responsible for the mortgage even though you, for all intents and purposes, don’t own the house anymore.
When you undergo novation, the transfer of the mortgage will include the mortgage lender. They agree to pass the mortgage from the seller to the buyer, transferring full liability of the contract.
When you go this route, the lender will run the buyer through the process of underwriting.
The underwriting process will allow the lender to assess how risky the buyer is as a borrower. When they are confident in the buyer’s ability to repay the loan and the likelihood that they will do so, they are willing to completely release the seller from responsibility for paying the loan back in the future.
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There are typically three types of loans that are assumable. However, any kind of mortgage loan could include an assumable mortgage clause.
The three most common types of assumable mortgages are FHA loans, USDA loans, and VA loans.
When both parties involved in the transaction meet the requirements for loan assumption, FHA loans are assumable.
For example, the person that is selling the property has to be using the house as their primary residence. The buyer will have to make sure that they are able to assume the loan before applying in the same manner they would for a regular FHA loan.
Once your application is received, the lender will make sure that you meet all the criteria.
The mortgage can then be assumed by the buyer if they are approved. The seller will still be responsible for the loan, though, unless they are released from it.
There are a few special circumstances where the lender won’t look into how creditworthy the buyer is, including inheritance and death. In these cases, the lender also doesn’t have to approve the sale.
For any loans that originated on or after December 15, 1989, lenders are required to approve the assumption of a mortgage loan so long as the buyer is creditworthy by their standards.
The standard FHA loan requirements include having a credit score of at least 580 and being able to put down at least 3.5% as a down payment. In order to assume an FHA loan, you’ll need to meet these standards.
People buying rural property can use USDA loans in order to obtain low interest rates and avoid making a down payment. Buyers have to meet a number of requirements in order to assume a USDA loan, including income and credit qualifications.
You usually need to have a credit score of at least 620 in order to assume a USDA. With some lenders, a credit score of at least 640 might be required. There are also location requirements and income limits when it comes to assuming a USDA loan.
The eligibility qualifications for USDA loans in 2022 include:
In general, USDA lenders also want borrowers to have a DTI below 41%. The loan requirements for USDA loans are flexible, though, and lenders might choose to approve applications where an individual is strong in certain areas but falls a bit short in others.
It’s worth noting that the mortgage can’t be transferred from one party to another if the seller is delinquent on their monthly loan payments.
In many instances, USDA loans assumptions actually come with new terms and a new interest rate.
In some circumstances, however, the same rate and terms can be passed on without the buyer needing to meet eligibility requirements. Examples include the transfer of a USDA loan within families.
Qualified military members and their spouses can get mortgages through the Department of Veterans Affairs. If you are interested in assuming a VA loan, however, you don’t have to be a member of the military. You will, however, have to be approved by the lender for the mortgage assumption.
Even though you don’t have to be a member of the military to assume a VA loan, many of the people who do assume these loans tend to be in the U.S. military.
Buyers are able to assume VA loans freely for loans that originated before March 1, 1988. What this means is that, in these cases, the buyer doesn’t have to receive the approval of the lender or the Department of Veterans Affairs in order to assume the loan.
For loans originating after this date, the buyer has to pay a processing fee and be deemed creditworthy by the lender in order to assume the mortgage.
There isn’t a set minimum credit score for assuming a VA loan. However, lenders often look for an individual to have a credit score of at least 620. In this transaction, there is an additional funding fee of 0.5%.
Mortgage contracts typically have to contain a clause that allows for a mortgage to be assumable. The reason for this is that mortgage assumption usually requires that the seller’s lender looks at the financial situation of the buyer. In a typical home sale, this wouldn’t occur.
There are exceptions to this rule, though. The reason for these exceptions is to help protect individuals that are dealing with major life events.
Two primary examples are after death or divorce. Families may be able to transfer their mortgaged assets during these types of situations without having to go through the process of receiving approval from the lending institution.
In most cases, conventional loans aren’t assumable. This is because conventional home loan contracts almost always contain a “due-on-sale clause.” This clause gives the lender the right to ask for the full outstanding loan balance at the exact moment the property exchanges hands through a sale.
Your mortgage might be eligible for assumption, however, if you meet certain financial qualifications and you have a conventional adjustable rate mortgage (ARM). There are two mortgage agencies that set the guidelines for this type of loan, Fannie Mae and Freddie Mac. Fannie Mae allows ARMs to be assumed, so long as the borrower doesn’t convert the mortgage to a fixed-rate loan.
If you’re a real estate investor, you might be interested in assumable mortgages as a way to keep the costs of buying property as low as possible. Even if you’re just shopping for your primary residence, this can be an appealing option.
As with all things, there are advantages and disadvantages to assuming mortgages. On top of that, the specific circumstances of the property and the loan will have a big impact on whether or not it makes sense for you.
If you’re selling a property, having an assumable mortgage can be appealing because it can make the property more desirable to buyers. This is particularly true if you have a low rate and little equity.
As the buyer, though, there are additional advantages.
Depending on the current mortgage rates and what the rates are for the property you’re interested in assuming the mortgage for, you might be able to lock in a lower interest rate by assuming a mortgage than originating a new one.
The interest rate you agree to has a huge impact on how much money you spend over the life of a loan. For example, let’s say that the mortgage rate right now is 5%. You’re interested in assuming the mortgage for a property that has an interest rate of 3%.
If you take out a loan for $200,000 for thirty years at a 5% interest rate, you’re paying $186,511.57 over the life of the loan.
If you took out the same loan at a 3% interest rate, however, your total interest paid on the loan would be $103,554.90, saving you more than $80k over the life of the loan.
For this reason, one of the biggest benefits of assuming a mortgage is the ability to get a lower interest rate than you would be able to with a new loan.
As mentioned above, this can also be good news for sellers because it can help to attract buyers.
Some of the costs on assumed mortgages are capped, meaning that you will most likely have lower closing costs when you assume a mortgage than if you get a new loan.
When a property is transferred from one party to another through assumption, the lender usually doesn’t require an appraisal. This can remove the cost of getting an appraisal as well as avoid the potential issues that can crop up during the process.
That being said, buyers might still choose to get an appraisal on their own in order to make sure that they are paying a reasonable price for the property.
If you’re assuming a mortgage loan of $50k for a home valued at $400k, that’s not a very big win. When you show up to the closing, you’re going to need to have $350,000 to give to the seller in order to cover their equity.
However, when the seller has a small amount of equity in the property, it can keep your out-of-pocket costs very low.
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There are quite a few downsides to assumable loans that you’ll want to consider before you choose to purchase a property this way. Let’s take a look at some of the primary disadvantages of assuming the mortgage on a property.
In most cases, you won’t be able to assume a mortgage without meeting the income and credit requirements of the lender. The reason for this is that the lender sees it as far too risky to release the current lender from their liability if they don’t know about your creditworthiness.
You might be on the hook for quite a bit of cash if the seller has a lot of equity in the property. This can make it a less appealing option for buyers and less advantageous to sellers.
If you need a second mortgage in order to make this happen, lenders might not be interested in cooperating anymore. It’s a good idea to get a sense of how big your down payment will need to be and whether the lender will accept you using another loan in order to cover the down payment.
It’s also worth noting that the person assuming the mortgage in this instance is left with two mortgages instead of one. In general, the risk of defaulting on mortgages increases when there is more than one loan to manage.
One potential downside of assumable mortgages is that the buyer is limited to the existing lender. You’ll still have to apply and get their consent by going through the approval process, but you don’t get to shop around when it comes to lenders.
There might be additional fees to watch out for if you assume a mortgage. There might be ongoing mortgage insurance payments, for example, or loan assumption fees to cover.
If you are considering transferring a property to another person through assumption, it’s important to understand that you could potentially be held liable if they default on their loan. You’ll want to make sure that you are released from liability for the mortgage by the lender.
If you have a VA-backed mortgage on a property and you sell it through assumption, you won’t be able to utilize your VA loan entitlement until the loan is paid off in full. The exception to this, however, is if the buyer is a veteran with entitlement that qualifies.
This is one of the reason that most VA loan assumptions are other military members, even though being a member of the military isn’t required for people assuming VA loans.
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In almost all cases, you will need to get approved by the lender before you can assume a mortgage. There are four primary steps you will need to take in order to take on an assumable mortgage.
Before you begin the process of trying to assume a mortgage, you’ll want to make sure that it’s even possible.
Confirm that the loan is assumable and that the lender will allow the assumption. You’ll also want to double-check with the lender that the loan payments of the borrower has been being paid consistently.
Though you can save quite a bit of money by assuming a mortgage, there are still costs associated with the process.
How much you put down as a down payment will depend on the seller’s equity in the property. There will also be closing costs to deal with. The good news is, though, that these are usually lower for a mortgage assumption than they are for originating a new loan.
Different lenders will have their own processes for applying for a loan assumption. Though the steps you take might appear a bit different, they will usually require that you fill out an application, provide identification, and complete other forms.
Once the lender has approved your assumption of the mortgage, there will be closing paperwork to deal with, just as there would be if you were originating a brand-new loan.
Depending on the circumstance, you might be signing a release of liability contract. This is a document that will free the seller from responsibility in regard to the mortgage loan.
Assuming the mortgage on a rental property could be a reasonable route, so long as a number of factors line up in your favor. If there’s a property you want to purchase, you’ll want to make sure that the mortgage is assumable before starting to pursue this option.
Of course, you’ll also want to consider the purchase price of the property and how much equity the current owner has to determine how much cash you’d have to put down.
Next, you can start digging into the rates and terms for the mortgage to determine whether the whole package is more appealing to you than getting a new loan or paying in cash.
Then, you’ll want to take a look at whether the lender will consider you creditworthy and approve the assumption.
You’ll then need to compare this information to the rates, down payment, terms of the loan, and more that you would be receiving if you took out a new loan. While the assumption process can be simpler and more straight-forward than getting a new loan, it’s not worth doing if it doesn't provide enough benefits in the long run.
Only you can decide whether assuming a mortgage is the right choice when it comes to funding your next rental. In general, though, you’ll want to become very familiar with the particulars of the process to ensure that you don’t meet any unexpected surprises along the way.
No matter where you are in your real estate journey, you know how important it is that the numbers lean in your favor when you own rentals. To help you identify properties that will help you meet your financial goals, use our rental property calculators.
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