Assumable Mortgage: What It Is And How It Works
Victoria Araj5-minute read
March 09, 2022
There are many ways for prospective home buyers to finance the purchase of their new house. There are various types of mortgages to choose from, all of which provide specific benefits depending on your needs as a borrower.
One mortgage type that might be worthwhile for some buyers to consider is an assumable mortgage. Let’s explore this borrowing option, how it works and whether it’s the right option for you.
What Is An Assumable Mortgage?
An assumable mortgage provides a buyer the opportunity to purchase a home by taking over the seller's mortgage loan. One reason buyers decide to buy a home with an assumable mortgage is to take advantage of financing with a lower interest rate if rates have risen since the seller originally purchased the home.
Purchasing a home this way isn't always the best path to take, especially since not all mortgages are assumable. Before you decide to take over a seller's mortgage, you'll need to consider these essential details.
Which Mortgages Are Assumable?
Don't assume all home loans are the same. Typically loans that are insured by the Federal Housing Administration or backed by the Department of Veterans Affairs or United States Department of Agriculture 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. In most cases, conventional mortgages are not assumable.
Here are a few things you need to know if you decide to take over an FHA loan. Newer FHA loans require that both buyer and seller 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 go through the standard application process for an FHA loan.
The good news is that for buyers, FHA loans require a smaller down payment of 3.5%, making it an attractive and more affordable option for first time home buyers. Plus, FHA mortgages are considered more accessible to buyers with a less than perfect credit history since credit scores must be above 580 to apply.
Before you apply for any mortgage, brush up on ways to improve your credit score to put your best foot forward in your application.
Backed by the Department of Veterans Affairs, a VA loan is available to eligible military members, service members and their spouses. A buyer who is not a military member or service member can apply for a VA loan assumption.
Depending on how the loan was set up, a lender may need to have the loan also approved by the Regional VA Loan Center, which may take additional 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 that fall in this category do not need to obtain lender approval, but may still be liable for making payments if a buyer fails to pay their mortgage on time. However, buyers may want to think twice before taking over these types of loans since mortgages originated in the late 1980s tend to have higher interest rates.
How Does An Assumable Mortgage Work?
An assumable mortgage works much the same as a traditional home loan, except the buyer is limited to financing through the seller's lender. Lenders must approve an assumable mortgage. If entered informally, sellers run the risk of having to pay the full remaining balance upfront. Sellers also risk buyers missing payments, which can negatively impact their credit score.
One major advantage is that an appraisal is not required in these instances, which can potentially save buyers hundreds of dollars. Buyers should still order a home inspection to check for any signs of repair issues with the property. Once the buyer closes on the home, the seller will no longer be liable for the mortgage payments.
Pros And Cons Of Assumable Mortgages
When determining the pros and cons of taking over a mortgage, consider any additional costs, paperwork and time frames needed to process the loan. While it may make sense to avoid higher interest rates through the seller's lender, it may be beneficial to shop around before committing to anything officially. Specialty mortgages sometimes require additional time for approval by government agencies or require higher down payments, depending on the type of the loan.
Pros Of Assumable Mortgages
Assumable mortgage homes for sale have a significant marketing advantage. Buyers looking for a simplified home buying process and a potentially lower interest rate make assumable mortgages very attractive.
Lower interest rates mean higher savings for buyers, potentially in the thousands. Plus, without the need for an appraisal, buyers have the option of pocketing a few hundred dollars instead of paying additional fees.
Cons Of Assumable Mortgages
The grass isn't always greener on the other side. There are often additional risks involved with assumable mortgages, especially when it comes to VA home loans. If a buyer takes over a freely assumable mortgage and transfers ownership to an undisclosed third party, sellers may be unaware of the transaction, increasing the potential for default payments.
Sellers of homes with VA loans may lose their entitlement altogether, affecting their eligibility for future VA home loans. To prevent this from happening, sellers need to obtain a release of liability after closing and provide proof to the Department of Veterans Affairs to reinstate their entitlement.
Buyers are also limited to the original terms and conditions of the seller's lender, restricting the ability to search for more competitive rates or terms.
How To Qualify For An Assumable Mortgage Loan
To qualify for an assumable mortgage, lenders will check a buyer's credit score and debt-to-income ratio (DTI) to meet loan requirements. Additional information such as employment history, income information, and asset verification for a down payment may be needed to process the loan.
It's important to speak with a qualified mortgage expert regarding the specific documents necessary to qualify for an assumable loan. Although it's up to the seller's lender or agency to approve this type of loan, finding the right lender to buy a home can give you peace of mind.
How Much It Costs To Assume A Mortgage
You may need to be prepared to take out a second home loan or bring a large amount of money toward closing costs. One significant disadvantage is that homes with a higher value than the current remaining loan balance require a larger down payment, making this option more expensive.
For example, if the purchase price is $175,000, and the remaining loan balance is $100,000, a buyer will need to bring the difference to closing. VA home loans also typically require a .5% funding fee of the loan balance from the buyer.
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 need to make sure that the person responsible for the loan still meets loan guidelines.
So, additional information from the person taking over the loan will need to be verified, much like a standard home loan application. Income statements, asset verification and creditworthiness are necessary to ensure that the borrower can still make the minimum monthly payments on the loan.
In short, it's critical to speak with a real estate expert when determining the right course of action when it comes to buying or selling a home.
The Bottom Line
Mortgage assumption can be a valuable option for those looking for the possibility of a lower interest rate and a simpler home buying process. If you’re willing to take the risk and put trust in your new home’s seller and their lender, there’s a chance the path to homeownership could end up being a lot less of a headache.
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