There are many types of mortgages for homebuyers to consider in the U.S. Assumable mortgages aren’t as common as others, but they can offer a wealth of benefits in the right circumstances. Let’s find out more.
What Is an Assumable Mortgage?
An assumable mortgage is a financial agreement in which a homebuyer takes over, or assumes, the seller’s outstanding mortgage balance and its terms when buying a home, rather than taking out their own loan. Usually, it’s a transaction between buyers and sellers who are related.
For example, you can assume your parents’ mortgage in case you inherit their property, and there’s still an outstanding balance left on it. Or you can assume your partner’s mortgage in case of a divorce if your name is listed on the house title but not on the initial loan.
How Does an Assumable Mortgage Work?
Like any loan, an assumable mortgage will require the lender’s approval before any changes are made to the initial contractual agreement. Therefore, even though, as a buyer, you are taking over the seller’s loan, you will still need to prove to the lender that you’re in a financial position to make mortgage payments. As a result, you will need to meet the lender’s requirements when it comes to credit score and credit history, income and debt-to-income ratio to qualify for a loan.
Once the lender approves your mortgage assumption application, you will take over the title of property as well as the seller’s remaining principal balance. Given the nature of an assumable mortgage, the seller has already paid off a part of his loan. As the buyer, you will continue to pay the remaining balance of the original loan in monthly installments. At this point, the seller may also request a release of liability from the loan to protect themselves in case the buyer defaults on the loan repayments.
Are All Mortgage Types Assumable?
In the U.S., the most common types of assumable mortgages are government-backed loans such as the Department of Veterans Affairs (VA), Federal Housing Authority (FHA) and U.S. Department of Agriculture (USDA) loans. Here are some key factors to keep in mind about each:
Although VA loans are granted to military members and their spouses, you don’t have to be a military service member to assume a VA loan. If the loan originated before March 1, 1988, it can be assumed freely without the Department of Veterans Affairs approval.
All FHA loans are assumable as long as the buyer and seller meet the lender’s requirements. For example, the property must be used as a primary residence by the seller, while the buyer must meet the lender’s criteria when it comes to creditworthiness.
An USDA loan is assumable if the property is in a rural region and the buyer has an income suitable for this type of mortgage. However, they must also meet the lender’s debt-to-income ratio, as well as credit score requirements. As a bonus, the U.S. Department of Agriculture doesn’t charge the 1% funding fee for new loans when assuming an existing USDA loan.
Conventional loans are not assumable because they come with a due-on-sale clause. However, some exceptions do exist. For example, loans backed by Fannie Mae are usually assumable if they’re adjustable-rate mortgages. But if the mortgage switches to a fixed-rate loan, it’s no longer assumable. Conventional lenders can also overlook due-on-sale clauses if the transfer of ownership is between relatives and not third-party buyers.
Is an Assumable Mortgage a Good Idea?
Depending on the circumstances, assuming a mortgage can work out in your favor. The lower interest rates that often come with assumable mortgages can be very attractive to buyers, just like the reduced closing costs. If the outstanding balance is low enough, the buyer may not even have to secure a new line of credit. The downside is that an assumable mortgage can pack many hidden costs.
If the home’s value is greater than the remaining loan balance, the buyer will need to make up for that difference. For example, if the home is valued 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 a HELOC, which can strain the buyer’s budget and negate the benefits of assuming the mortgage in the first place. Also, if the seller has not reached a 20% equity in their home, the buyer will be required to take out private mortgage insurance (PMI).
Mortgage assumption is an attractive alternative to taking out a conventional loan and can even reduce your homebuying expenses. However, it’s always best to weigh out the risks in advance, especially if it looks like it could become a long-term financial strain.