What is an assumable mortgage and how does it work?

Prospective home buyers can finance a new house purchase in a number of ways. With so many mortgage possibilities to choose from, selecting the right loan program can be tricky, though.

One home financing option that some buyers might not be aware of is an assumable mortgage.

Is an assumable mortgage the most appropriate choice for your financial situation and home buying needs?

What is an assumable mortgage?

An assumable mortgage allows the buyer to purchase a home by taking over the seller’s mortgage loan. Some buyers prefer to purchase a home with an assumable mortgage because it may allow them to take advantage of a lower interest rate.

This will be the case if interest rates have risen since the seller purchased the home and the seller signed up for a fixed-rate mortgage.

What home loans are assumable?

Not all home loans are assumable. In fact, most conventional mortgages – those not backed by a government agency but by a private lender – aren’t assumable. One exception with conventional loans occurs if someone is a “successor in interest,” meaning the property is transferred to them during another person’s lifetime or after that person’s death. You can also assume an adjustable-rate mortgage that’s outside of its initial fixed period.

However, loans insured by the Federal Housing Administration (FHA) or backed by the Department of Veterans Affairs (VA) or United States Department of Agriculture (USDA) are assumable as long as specific requirements are satisfied.

For most FHA and VA loans, a seller must obtain lender approval for an assumable mortgage.

FHA loans

Newer FHA loans require both buyer and seller to meet specific criteria for an assumable mortgage. Sellers must live in the home as a primary residence for a set amount of time, and buyers must follow the standard FHA loan application process.

FHA mortgages are more accessible for buyers with a lower credit score. Most lenders require a minimum score of 580 for FHA loan approval, although some allow for a credit score as low as 500 if the borrower can make a 10% down payment. FHA loans require a down payment of only 3.5% of the purchase price if the borrower’s credit score is 580 or above.

VA loans

VA loans – which come with several perks, the most notable being a zero down payment requirement – are available to active-duty service members, veterans, members of the National Guard and Army Reserve, and surviving spouses who all meet certain requirements for eligibility. A buyer who’s not a qualified current or former military service member or surviving spouse can apply for a VA loan assumption. If someone who doesn’t usually qualify for a VA loan takes over the loan, the seller loses their VA entitlement.

Depending on how the loan was set up, a lender may also need to have the loan approved by the VA Regional Loan Center. This step requires extra time to process paperwork.

In very rare cases, a buyer might come across a freely assumable loan that applies to any VA loan closed on or before March 1, 1988. Sellers who fall in this category don’t need to obtain lender approval. However, they may still be liable for making payments if a buyer fails to pay their mortgage on time, so it’s best to still get a liability release from the VA.

USDA loans

USDA loans, which like VA loans allow for no money down, are also assumable. The most important piece of information to know here is that borrowers will need approval from both their lender and the USDA in most instances. The exceptions are successor-in-interest cases, which we discussed earlier in the context of conventional loans. The seller maintains responsibility for the mortgage until the buyer assumes liability.

Rocket Mortgage^® doesn’t offer USDA loans at this time.

How does an assumable mortgage work?

An assumable mortgage is basically like a traditional home loan, aside from the fact that the buyer can only get financing through the seller’s lender. As mentioned, lenders must approve an assumable mortgage. If done without approval, sellers run the risk of having to pay the full remaining balance upfront. Sellers also risk buyers missing payments, which can negatively impact the credit score of both the buyer and seller.

One major advantage of an assumable mortgage is the absence of an appraisal requirement. Skipping an appraisal can save buyers hundreds of dollars. Buyers should still order a home inspection, though, to check for any repair issues with the property. Once the buyer closes on the home, the seller will no longer be liable for the mortgage payments.

What loans are not assumable?

Not all home loans are assumable. In fact, most conventional mortgages — those not backed by a government agency, but rather by a private lender — aren’t assumable. One exception with conventional loans occurs if someone is a “successor in interest,” in which the property is transferred to them during another person’s lifetime or after that person’s death. Additionally, adjustable-rate mortgages may be assumable once they’ve moved past their initial fixed period.

Pros and cons of assumable mortgages

Before deciding if an assumable mortgage is worth pursuing, you’ll want to consider any additional costs, paperwork and time frames needed to process the loan. While it can be beneficial to avoid higher interest rates through the seller’s lender, you should fully understand the pros and cons of this type of mortgage before formally committing to one.

Pros

Here are some advantages of assumable mortgages:

• Homes possibly being easier to sell: Buyers looking for a simplified home buying process and a reduced interest rate may find assumable mortgages very attractive based on the potential for a lower rate.
• The potential for buyers to save money: Lower interest rates may save buyers thousands of dollars over the life of their loan. Plus, without the need for an appraisal, buyers can save a few hundred dollars upfront.
• Limited closing costs: When home buyers assume a mortgage, the FHA, VA and USDA limit how much they’ll have to pay in closing costs. As a result, a home purchase is more affordable.

Cons

Here are some disadvantages of assumable mortgages:

• Increased financial risk: Sellers often face additional risks involved with assumable mortgages. For example, if a buyer takes over a freely assumable mortgage and transfers ownership to an undisclosed third party, sellers may be responsible for covering any mortgage payments that the new owner misses.
• No opportunity to shop around: Buyers are limited to the original loan conditions set by the seller’s lender. As a result, the buyer’s ability to search for a more competitive mortgage rate and repayment term is limited.
• The potential to not be approved: For most assumptions, buyers must meet certain requirements of the lender and/or investor in the mortgage. For example, newer FHA loans require sellers and buyers to both satisfy specific FHA criteria.

How to qualify for an assumable mortgage loan

Follow the steps below to start the process of assuming a mortgage loan:

1. Find a property you want to purchase and verify the mortgage loan attached to the home is assumable.

2. Make sure your credit score and debt-to-income ratio (DTI) meet the minimum requirements for this type of real estate transaction.

3. Compile all necessary documentation to process the loan. This includes employment history, explanations of income for each loan applicant, and asset verification for a down payment.

4. Fill out and submit an application to obtain an assumable mortgage.

5. During the closing process, pay closing costs and fill out additional paperwork as required by the lender.

How much does it cost to assume a mortgage?

The cost to assume a mortgage loan will vary with the investor in the mortgage as well as the policies of the lender approving the assumption. Fees typically associated with the assumption are based on either a percentage of the unpaid principal balance or a flat amount. Assumption fees may be limited by state law, so check the regulations in your area.

Those assuming VA loans will have to pay the VA funding fee in most cases. That fee is 0.5% of the remaining mortgage balance for assumptions. You’re exempt from paying the funding fee if:

• You currently receive VA disability payments
• You’re a surviving spouse who receives Dependency and Indemnity Compensation (DIC) benefits
• You’re an active-duty service member who returned to duty after receiving a Purple Heart

Assuming a mortgage after divorce or death

Sometimes assuming a mortgage is a result of the death of a family member or a divorce. In these cases, the lender will make sure the person responsible for the loan still meets established minimum requirements.

Much like with a standard home loan application, the lender will review the financial qualifications of the person taking over the assumable mortgage. Specifically, the lender will take a look at the borrower’s income statements, asset lists and creditworthiness to ensure they can make the minimum monthly payments on the loan.

The bottom line

Mortgage assumption can be a valuable option if you’re looking for a lower interest rate and want to simplify the home buying process. If you trust the seller and their lender, an assumable mortgage – even with the risks it presents – could be the way to go.

Ready to begin your home buying journey? Get started with Rocket Mortgage today!