Assumable Mortgage: What It Is And How It Works

There are many ways for prospective home buyers to finance the purchase of their new house. With so many types of mortgages to choose from – all of which provide specific benefits depending on your needs as a borrower – choosing the right type of loan can be tough.

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.

An assumable mortgage allows the buyer 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.

Not all home loans are assumable. Unfortunately, most conventional mortgages are not assumable. One of the exceptions is if someone is a successor in interest based on having the property transferred to them during someone's lifetime or after their passing. You can also assume an adjustable-rate mortgage that's outside its initial fixed period.

However, loans that are 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

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.

FHA mortgages are considered more accessible to buyers with a less-than-perfect credit history since credit scores must be above 580 to apply with most lenders.

Before you apply for any mortgage, brush up on ways to improve your credit score to put your best foot forward in your application.

VA Loans

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 qualified current or former military service member can apply for a VA loan assumption. It should be noted that if the loan is assumed by someone who wouldn't ordinarily qualify for a VA loan, the seller gives up their VA entitlement.

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, so it's best to get a liability release from the VA anyway.

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.

USDA Loans

USDA loans are also assumable. The most important thing to know here is that in most circumstances, you may need approval from both your lender and the USDA. The exceptions to approval are the same successor in interest cases we mentioned earlier with conventional loans. The seller maintains responsibility for the mortgage until the buyer assumes liability.

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

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 typically 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 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 repair issues with the property. Once the buyer closes on the home, the seller will no longer be liable for the mortgage payments.

When determining the pros and cons of taking over a mortgage, you’ll want to 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. Here’s what you need to know to decide if taking on an assumable loan is the right choice.

Pros Of Assumable Mortgages

• May make homes easier to sell: Homes for sale with assumable mortgages have a significant marketing advantage. Buyers looking for a simplified home buying process and a potentially lower interest rate may find mortgages very attractive based on the potential for a lower interest rate.

• May save buyers money: Lower interest rates may save buyers thousands of dollars over the life of their loan. Plus, without the need for an appraisal, buyers have the option of pocketing a few hundred dollars upfront instead of paying additional fees.

Cons Of Assumable Mortgages

• Increases financial risk: The grass isn't always greener on the other side. Sellers often face additional risks involved with assumable mortgages, especially when letting buyers assume VA home loans. If a buyer takes over a freely assumable mortgage and transfers ownership to an undisclosed third party, sellers may still be responsible for covering any mortgage payments that the new owner misses. If sellers are unaware of the transaction, there’s an increased risk of default payments. This can be mitigated with a request for a release from the VA.

• Potential for lost entitlement: Sellers with assumed VA loans may lose their entitlement altogether if the new owner defaults, 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.

• No opportunity to shop around: Buyers are limited to the original terms and conditions of the seller's lender, restricting the ability to search for more competitive rates or terms.

• May not be approved: For most assumptions, you'll have to meet the credit qualification standards of the lender and/or investor in the mortgage. There's no guarantee that buyers will be approved.

To qualify for an assumable mortgage, lenders will check a buyer's credit score and debt-to-income ratio to see if they meet minimum requirements. Additional information such as employment history, explanations of income for each applicant, 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 help you buy a home can give you peace of mind.

The cost to assume a mortgage loan may vary depending on the investor in the mortgage as well as the policies of the lender approving the assumption. There are typically fees associated with the assumption that are either based on 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, which is 0.5% of the remaining mortgage balance for assumptions. You're exempt from paying the funding fee if one of the following applies:

• 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

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 the minimum requirements they’ve set.

Additional information from the person taking over the loan will need to be verified, much like a standard home loan application. The lender will review income statements, asset lists and borrower's creditworthiness to ensure that they can still make the minimum monthly payments on the loan.

It's best to speak with a Home Loan Expert before you agree to assume a loan.

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.

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