What is an assumable mortgage and how does it work?
There are many types of mortgages for home buyers in the United States. Assumable mortgages aren’t as common as others, but they can offer a host of benefits under the right circumstances. Let’s find out more.
What is an Assumable Mortgage?
An assumable mortgage is a financial arrangement in which a buyer assumes, or assumes, the seller’s outstanding mortgage balance and terms when purchasing a home, rather than taking out their own loan. Usually it is a transaction between related buyers and sellers.
For example, you can assume your parents’ mortgage in case you inherit their property, and there is still an outstanding balance on it. Or you can assume your partner’s mortgage in the event of a divorce if your name is on the title deed but not on the original loan.
How does an assumable mortgage work?
Like any loan, an Assumable Mortgage will require lender approval before any changes are made to the original contractual agreement. Therefore, even if, as the buyer, you take over the loan from the seller, you will still have to prove to the lender that you are in a financial position to make the mortgage payments. Therefore, you will need to meet the lender’s requirements for credit rating and credit history, income, and debt-to-equity ratio to qualify for a loan.
Once the lender approves your application for mortgage assumption, you will take over title and the remaining principal balance from the seller. Given the nature of an assumable mortgage, the seller has already repaid part of his loan. As a buyer, you will continue to pay the remaining balance of the original loan in monthly installments. At this point, the seller can also apply for a loan liability waiver to protect themselves in the event the buyer defaults on loan repayments.
Are all types of mortgages assumable?
In the United States, the most common types of assumable mortgages are government-backed loans, such as Department of Veterans Affairs (VA), Federal Housing Authority (FHA), and U.S. Department of Health loans. agriculture (USDA). Here are some key factors to keep in mind for each:
Although VA loans are given to military members and their spouses, you do not have to be a military service member to take on a VA loan. If the loan originated before March 1, 1988, it can be freely assumed without the approval of the Department of Veterans Affairs.
All FHA loans are assumable as long as both buyer and seller meet the lender’s requirements. For example, the property must be used as the seller’s primary residence, while the buyer must meet the lender’s creditworthiness criteria.
A USDA loan is assumable if the property is in a rural area and the buyer has an income suitable for this type of mortgage. However, they must also meet the lender’s debt ratio, as well as credit score requirements. As a bonus, the US Department of Agriculture does not charge the 1% finance fee for new loans when it assumes an existing USDA loan.
Conventional loans are not assumable because they come with an enforceability clause. However, some exceptions exist. For example, loans guaranteed by Fannie Mae are generally assumable if they are adjustable rate mortgages. But if the mortgage changes to a fixed rate loan, it is no longer assumable. Conventional lenders can also ignore enforceability clauses if the transfer of ownership is between relatives and not between third-party buyers.
Is an assumable mortgage a good idea?
Depending on the circumstances, taking on a mortgage can work in your favor. The lower interest rates that often come with assumable mortgages can be very attractive to buyers, as can lower closing costs. If the outstanding balance is low enough, the buyer may not even need to obtain a new line of credit. The downside is that an assumable mortgage can lead to many hidden costs.
If the home is worth more than the remaining loan balance, the buyer will have to make up that difference. For example, if the house is appraised at $300,000, but the assumable mortgage is only $200,000, the buyer will need to cover the remaining $100,000.
Usually this requires taking out a second mortgage or HELOC, which can strain the buyer’s budget and negate the benefits of taking on the mortgage in the first place. Additionally, if the seller has not achieved 20% equity in their home, the buyer will be required to purchase private mortgage insurance (PMI).
Mortgage support is an interesting alternative to taking out a conventional loan and can even reduce your housing purchase expenses. However, it’s always best to weigh the risks up front, especially if it looks like it could become a long-term financial constraint.