What is an assumable mortgage?
With an assumable mortgage, the buyer assumes the seller’s existing mortgage obligations. A homebuyer can benefit by accessing the seller’s interest rate and terms, assuming a mortgage is especially appealing when current interest rates are far higher than they were when the seller obtained their loan.
Mortgage assumption is not always the best homebuying option. Some buyers would be better off obtaining an FHA, VA, USDA, or conventional loan on their own. Also, not all home loans are assumable.
How does an assumable mortgage work?
In an assumable mortgage, the buyer will assume responsibility for the loan and repay the remaining balance at the seller’s original interest rate.
However, assumable mortgage transactions do not account for the equity in a home. For example, suppose that the home you want to purchase is valued at and listed for $400,000, and the current owner’s loan balance is $300,000. If you assumed the mortgage, then you would be taking over a loan with a balance of $300,000. But the homeowner would still need to be compensated for the $100,000 of equity. In this scenario, you would need to either pay the $100,000 difference out-of-pocket or take out a second mortgage on the home. While the $100,000 mortgage will likely have a higher interest rate, the remaining $300,000 balance would be repaid at the lower interest rate.
Qualifications
Assumable mortgage loans can be a great option when interest rates are high. But in order to unlock the benefits of an assumable mortgage loan, you must first meet the mortgage lender’s qualifications.
Like other financial options, lenders will review your credit scores and ask for proof of income, verifying that you meet the debt-to-income (DTI) thresholds for the loan. You will also need to provide proof that you have the down payment or a pre-approval letter demonstrating that you are obtaining a second mortgage.
Types of assumable mortgage loans
Conventional loans are not assumable, but loans from the Department of Veterans Affairs (VA), U.S. Department of Agriculture (USDA), and Federal Housing Administration (FHA) are. Each has specific eligibility requirements.
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Buyers and sellers must meet assumption requirements when transferring FHA loans. The seller must be currently using the home as their primary residence.
Buyers will need to apply for an FHA loan independently. Their current loan services will confirm that the buyer meets current FHA requirements, including minimum credit score and maximum DTI limits. Sellers are still responsible for the loan unless the lender expressly states otherwise.
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VA loans are well known for their favorable terms and conditions. A few examples include the ability to buy a home with 0% down and the private mortgage insurance (PMI) exemption.
Although only Veterans, Active-Duty Military Personnel, and Widows of Service Members can obtain VA loans, non-Veterans can assume these mortgages. To qualify, applicants must meet stringent credit score and income requirements.
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USDA mortgages are designed to help homebuyers purchase properties in rural areas. These loans typically have lower interest rates than other mortgage products and don’t require a down payment. Borrowers must fall under USDA income limits to qualify.
Buyers interested in assuming a USDA mortgage loan must meet these same criteria. They will also need to obtain written approval from the United States Department of Agriculture to transfer the property title. Buyers can assume the seller’s terms and interest rate or take advantage of current rates if they are more favorable.
Assumable mortgage benefits
Assumable mortgage loans provide several benefits to prospective homebuyers.
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Lower interest rates
A lower interest rate is the biggest perk of assuming a mortgage. While you must meet credit score requirements to assume a mortgage, your score does not necessarily need to be as high as the borrower’s credit score when they initially obtained the loan. For instance, suppose that the seller’s credit score was well above the minimum threshold and rates were much lower when they acquired the loan. As long as your score meets the minimum, you are still eligible to assume the loan.
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Smaller closing costs
Closing costs on assumable loans are usually much lower because some fees related to the loan are capped. The closing costs will vary based on several factors, including which state you reside in and individual lender fees. With that information in mind, make sure to speak with one of the loan servicer’s mortgage brokers to get an estimate of your total closing costs.
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No appraisal
Generally, appraisals are not required when you assume a mortgage loan. Since the home has gained equity and the loan balance has decreased, it is assumed that the home is worth more than the remaining loan amount.
Assumable mortgage drawbacks
Homebuyers should also be aware of the potential drawbacks that can come with assumable mortgages.
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Only certain loans are eligible
Only USDA, FHA, and VA loans are eligible for mortgage assumption. Additionally, sellers may have to jump through a few hoops to release themselves of liability from the loan. This situation makes assumable mortgage loans less appealing to sellers if they have traditional offers on the table.
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A large down payment is required
The biggest obstacle to assuming a mortgage loan is the large down payment. You can obtain a second mortgage if you do not have the cash to cover the seller’s equity, but this situation can complicate things a bit. Depending on how much equity the seller has, it may be easier and more advantageous for you to obtain a traditional mortgage.
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More fees are included
While closing costs are generally lower with an assumable mortgage, additional fees can bring those costs up. For example, if the seller is still required to maintain private mortgage insurance, then you will be also. For FHA loans, PMI is required for the life of the loan, so you will eventually need to refinance to ditch this recurring expense.
VA and USDA loans also include hidden fees. When you assume a VA loan, you must pay a one-time 0.5% funding fee. With a USDA loan, you must pay a 0.35% guarantee fee for the life of the loan. These fees are based on the remaining mortgage balance at the time of the transaction.
How can you assume a mortgage?
The first step in assuming a mortgage is to get pre-approved for a loan. If you are targeting a certain type of loan, then you will need pre-approval only for that mortgage. If you have not yet found a property, then you could obtain pre-approval for both USDA and FHA loans.
Next, it’s time to find a reputable real estate agent and start house hunting. Let your agent know you are interested in an assumable mortgage and provide them with your pre-approval documents.
Once you have found a house, confirm that the seller financed it with an eligible type of loan. Work with your agent to create a competitive offer that includes either cash to cover the equity of the home or a pre-approval for a second mortgage.
Now all that is left to do is submit your bid and wait for a response.
If you want to buy a home and are willing to take a non-traditional path, then mortgage assumption can be a great option. Carefully weighing the pros and cons of each purchasing opportunity will help you find the ideal way to buy your new home.
