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You Should Know: Understanding Mortgage Assumption

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When most homeowners get financing to purchase a new property, they take out a brand-new mortgage for the home’s purchase price. The buyer undergoes the application and underwriting process before the lender presents them with their own loan. While this is one of the most common ways to finance a home purchase, there’s another option: The mortgage assumption.

What is a Mortgage Assumption?

A mortgage assumption allows one buyer to take over another buyer’s loan. The buyer who assumes the loan takes on the loan balance, interest rates, and repayment terms. In a mortgage assumption, the seller gets out of their loan and their home, without drama. The buyer could snag lower rates or purchase a property for a lower price.

Suppose you’re concerned about avoiding foreclosure. In that case, you may be wondering if a mortgage assumption could be a way for you to hand off your property to a buyer without facing a short sale or the foreclosure process. Keep reading to learn more about a mortgage assumption and when this type of loan works.

When would a mortgage assumption be a good option?

Mortgage assumptions occur for many reasons, including during divorce proceedings. If one spouse wants to keep the property, the other could buy their ex out of the mortgage or assume the mortgage by taking sole responsibility for the loan terms.

Additionally, sellers may look for mortgage assumptions when they’re having difficulty selling a property. Buyers who benefit from a mortgage assumption may be able to take over a loan that doesn’t require a down payment or has a lower interest rate than they can get through traditional means.

It’s typically much easier for a mortgage assumption to occur in a property transfer or inheritance where no new buyer is present. Traditional buyers can still get mortgage assumptions; it just might require a few extra steps.

Mortgage assumptions are also an option if you’ve inherited a property and want to keep the house.

What you need to understand about an assumable loan:

If you’re a buyer considering an assumable loan, the process isn’t as clear-cut as it sounds because property values change. For example, if a seller owes $200,000 on their house, but property values have increased since the purchase, and the home is now worth $250,000, the buyer doesn’t just get the house for the $200,000 mortgage. The buyer assumes the $200,000 mortgage and covers the $50,000 difference.

Buyers who purchase a home with a lot of equity may need to provide a sizeable down payment or take out a second mortgage.

Real estate agent or bank officer describes the loan interest to the customer with home purchase contracts or on office loans and interest rates.

What types of loans are assumable?

Most mortgage loans could undergo a loan assumption including:

FHA Loans: FHA loans require that the buyer and the seller both used and will use the house as a primary residence. Additionally, the seller’s lender will review the buyer’s credit history to determine if they’re eligible for the loan.

VA Loan: While only members of the military qualify for VA loans on application, a VA loan may be assumed by a civilian. If a buyer wants to take over a VA loan initiated before 1988, they may do so without the approval of the lender or VA. Otherwise, the lender and VA must approve the assumption.

USDA loan: Buyers may assume a USDA loan if they meet credit and income requirements. The USDA must approve the title transfer. However, the loan may not be transferred if the current buyer has missing payments.

What loans are not assumable?

In most cases, conventional loans are not assumable. In some cases, conventional loans with an adjustable-rate mortgage may qualify. If your current loan has a “due on sale” provision, that means that the entire balance of the loan is due when the title transfers to another person, so the loan likely doesn’t qualify.

What are the Benefits of a mortgage assumption

Mortgage assumptions have benefits and drawbacks. If you’re interested in assuming the loan on a property or using a mortgage assumption to offload a house, consider these pros and cons:

For the buyer

Pro: Buyers can save a lot of money. In addition to potentially snagging lower interest rates, buyers can save on closing costs. Since the loan is already in place, the buyer doesn’t need to have the home appraised.

Con: If the buyer offers to purchase the home for more than the remaining loan balance, they may be required to take on a second mortgage to cover the difference. This second mortgage could have a higher interest rate.

Pro:  When the buyer purchases the home with lower equity, they may be able to pay any difference in the purchase price and remaining loan balance in cash.

Con: Buyers may need a large down payment to qualify.

For the seller

There aren’t many downsides for sellers with an FHA or USDA loan. In most cases, the seller comes out ahead. The seller can offload their home, and they’re no longer responsible for the mortgage.

One downside for an FHA loan is Private Mortgage Insurance. The PMI only disappears once the loan is repaid or the borrower refinances. So, buyers who assume a mortgage with a PMI may need to refinance in the future or stick out the additional cost of the PMI.

If a seller has a VA loan, things might get more complex. VA loans offer an “entitlement” to borrowers. This entitlement allows the government to pay part of the loan balance if the borrower defaults on their loan.

For example, If a VA seller uses a mortgage assumption to sell their property, they may not be able to qualify for another VA loan if the entitlement remains tied to their previous property. Veterans can avoid this by using a mortgage assumption to sell to another qualifying military member.

How to Assume a Mortgage

First, it’s essential to understand that buyers and sellers must obtain approval from the lender to secure a mortgage assumption. If a buyer and seller do a side-deal, they could face severe consequences if the lender finds out. Lenders are within their rights to demand immediate repayment of the loan balance if they discover that the seller and buyer made the agreement without approval. Further, if the seller keeps the loan in their name while the buyer makes payments, the seller is still responsible for the loan balance.

Borrowers who want to assume a mortgage will need to undergo much of the same lending process as it would take to secure a new loan, including a credit check. However, the lender will not require an appraisal.

Can a seller use a mortgage assumption to avoid foreclosure?

Maybe. A mortgage assumption could release the original borrower from responsibility, but sometimes, it doesn’t. If the lender doesn’t remove the original borrower from responsibility, the new homeowner makes the monthly payments, but both the original borrower and the new homeowner are held accountable for the loan.

You may avoid foreclosure with a mortgage assumption if the new borrowers come to an agreement with the lender or pay the overdue amount.

Final thoughts

A mortgage assumption can be a valuable tool for buyers and sellers. However, this type of loan is only helpful in specific circumstances. Understanding the pros and cons of this type of loan will ensure you make the best decision for your finances. Both the buyer and seller could come out way ahead with a mortgage assumption in the right situation.

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