What are Assumable Mortgages?
An assumable Mortgage is a home loan that can be transferred from the seller to be taken over or “assumed” by the buyer, becoming their responsibility to pay off. Of course, this requires the approval of the lender servicing the loan, and even then, not all loans are assumable.
With an assumable mortgage, the buyer typically must be in agreement to take on the loan as it was originated for the original borrower (the seller) including the loan terms and interest rate. There are some cases where the terms are modified slightly, but this is a rare occurrence.
Types of Assumable Mortgage Loans
The following are all examples of assumable mortgages:
Federal Housing Administration Loans
The Federal Housing Administration (FHA) provides mortgage insurance on loans issued by approved lenders. With this insurance in place, you may be able to qualify for a mortgage without the “standard” 20% down payment. An FHA mortgage can be approved with as little as 3.5% down for qualified buyers.
To qualify for an FHA loan, you will need to show the lender that you have a regular source of income (proof of employment is required). You will also need to meet these requirements:
You must live in the home (or one of its units, if a multi-unit property) as your main residence.
Your credit score must be at least 500. Depending on your credit rating, you will need to make a down payment of between 3.5% and 10%. If your FICO® score is 580 or higher, you can qualify for the 3.5% down payment option. Borrowers with a FICO score between 500 and 579 must put down 10% of the purchase price.
Note: Lenders can apply additional requirements, known as overlays, to loan programs. That means that even if your credit is good enough to qualify by FHA standards, you may still have a hard time finding a lender to write your mortgage. Shop around a bit if your score is closer to 500 than 600.
As the buyer, you will have to pay an FHA insurance premium. This is either paid up front or wrapped into your loan. You will also pay an annual mortgage insurance premium that shrinks as you pay down your loan.
Your Debt-to-Income (DTI) ratio can’t be higher than 43%. To calculate this figure, take the total amount you pay for debt each month and divide it by your income. For example, if you have a gross family income of $5,500 each month and you’re paying off $2,000 in debt monthly, your DTI ratio is 36% (2,000 divided by 5,500).
Consider an FHA loan if you’re a first-time home buyer and you’re finding the prospect of saving 20% for a down payment a little daunting. By lowering the down payment requirement, you may be able to get into your own home sooner!
Veterans’ Administration Loans
Veterans’ Administration (VA) loans are guaranteed by the Department of Veterans Affairs. VA loans are available for currently serving members of the military, veterans, and surviving spouses.
You can assume this type of loan with the lender’s approval as long as you meet its credit requirements. If you’ve served in the military, your entitlement benefits (sort of like mortgage insurance that you’ve earned) will replace those of the original borrower. If not, you may be coasting on their benefits. Most of the time, VA loans are assumed only by other veterans for practical reasons.
Here’s an example: Bob Smith is a vet and purchased his house on Main Street using a VA mortgage. His entitlement benefit is now associated with the mortgage for the Main Street house. Bob puts his home up for sale and tells buyers he would consider letting them assume his mortgage.
John Black is really interested, and he makes an offer right away. Now, Bob has a decision to make. Does he sell his home and his loan, including his entitlement, to John? Bob won’t be able to buy his next house using the VA program because John is using his entitlement benefit. Generally speaking, Bob’s going to be better off telling John to get his own note.
John declines, but along comes Susan Porter, who also wants to assume the loan. The difference is that Susan is also a vet and has an entitlement benefit that the bank can substitute for Bob’s at closing. Bob is all for this, so he and Susan meet at the closing table and sign the papers. Like magic, Bob’s entitlement is freed up and Susan’s is now securing the note on Main Street.
Benefits of an Assumable Mortgage
As a home buyer, there are some definite advantages to buying a home where you can assume an existing mortgage.
More Attractive Interest Rate. Since you’re taking over the current owner’s mortgage, you are also getting the advantage of the lower interest rate that is currently in effect. Depending on the principal amount of the current mortgage, you could end up saving a significant amount of money.
Lower Closing Costs. Some of the closing costs associated with buying a home may not apply if you are assuming a mortgage. The fees for applying for and processing the mortgage should be lower than if you needed completely new funding.
Your lender must supply you with an estimate of the closing costs (now called the Loan Estimate Form) after you apply to assume the mortgage. You should receive a list of your actual closing costs (the Closing Disclosure Form) at least three days before closing.
Shorter Mortgage Term. If the current owner took out a 30-year mortgage and has been making payments on the loan for five years, your term will be 25 years (the time remaining on the original 30-year term).
Drawbacks of an Assumable Mortgage
As a home buyer, there are drawbacks to assuming the existing mortgage on a home. Before you decide to go this route, be sure to consider them.
Larger Down Payment. Since you can only assume the principal amount owing on the home you want to buy, you will need to make a larger down payment to cover the difference.
For example, if the home you want to buy has an existing mortgage of $140,000 and the selling price is $200,000, then you would have to make a $60,000 down payment to cover the difference. This amount may be too steep for many prospective buyers.
Potential Second Mortgage. If you don’t have enough funds available for your down payment to make up the difference between the amount of the assumable mortgage and the selling price, you will need to take out a second mortgage to make up the difference. This creates some possible difficulties for you as a buyer.
The first thing you need to be aware of is that second mortgages are riskier for a lender, which means they carry a higher interest rate. Run the numbers to find out how much it would cost to make two mortgage payments on the home. Is it still affordable for you when you take the higher interest rate from the second mortgage into account?
How to Assume a Mortgage
The process for assuming a mortgage is similar in many ways to taking out a new one. The lender needs to be satisfied that you have the financial means to pay back the loan. It also wants to know that you are responsible enough to make those payments as agreed.
1. Meet with the Lender. Your first step is to sit down with the lender that is holding the mortgage on the home you want to buy. When you make the appointment for the initial meeting, explain that you are interested in discussing the possibility of assuming the mortgage at [street address, city or town].
2. Get Confirmation of Status of the Existing Loan. Ask the lender to confirm in writing that the mortgage is assumable. You also want a statement confirming the balance and the interest rate that the lender is charging on the loan. If you need to apply for a second mortgage, the lender for that loan will need this information. If you can, use the same lender for both loans. This will simplify your life dramatically.
3. Provide Requested Documents. The lender will ask you to provide a number of documents relating to your financial health and your ability to pay back the loan. They may include some or all of the following:
Recent pay stubs (covering the last month)
W-2s for the past two years (or your most recent profit-and-loss statement if you’re self-employed)
Bank statements for the past 60 days
Personal and business income-tax returns
You will also be asked for a copy of the signed Purchase and Sales Agreement.
4. Complete an Application Form. The lender will ask you to fill out a loan application form. Be sure to take your time when completing it so that your answers are complete and accurate. According to Bank of America, any errors or omissions will mean your application will take longer to process. You may even run the risk of having your application denied.
Keep a copy of all signed forms in a safe place. You can scan them and store them electronically or place them in a safe-deposit box.
5. Get Your Credit Rating Checked. Be prepared to have your credit report pulled by the lender shortly after you submit your application documents.
6. Answer Follow-Up Questions from the Lender. Once the lender receives your application form, a loan processor will be assigned to your loan assumption. The loan processor will be your contact person and will answer any questions you have about assuming the mortgage.
Once your application has been processed, the loan processor will contact you to let you know if it is approved. If it is, you will need to sign more documents.
7. Sign Assumption Agreement and Release. The assumption agreement is an agreement between the home seller and the home buyer. You are agreeing to take over the existing mortgage on the property at the same interest rate and terms that the home seller has in place with the lender. You are also releasing the home seller from any liability for the loan once the sale of the property has been finalized.
From the current homeowner’s point of view, the release is very important. If it isn’t signed and you don’t keep up with your mortgage payments, the owner is still on the hook for the mortgage balance.
8. Attend the Closing. This is the step where the final documents are signed and the house officially changes ownership. All closing costs are due at this time.
Assumable mortgages can be a great option if you’re in the right position monetarily and the perfect assumable situation presents itself. In the next few years, as interest rates rise, an assumable loan may mean the difference between the neighborhood you really want and the neighborhood that’s maybe not so hot.