With interest rates high, and affordability low, property values don’t seem to be going up quickly any time soon. It is not the ideal time to buy, in my opinion. Maybe you absolutely must buy a home now, because you are moving across the country or need a place that is bigger or need lower payments, or have some other reason.
One option to consider is assuming a seller’s loan that has a low-interest rate. Not just VA loans but also FHA and USDA loans are assumable. The upside is a potentially much lower rate. Also, closing costs are capped. The downside is you have to come up with a lot of cash, to buy out the seller’s equity. You may also need to pay mortgage insurance premiums. But the low rate will help you build equity quicker.
What Is an Assumable Mortgage?
An assumable loan allows an existing borrower to transfer the interest rate and repayment duration of their original mortgage to a new homebuyer; these details remain constant – for example, if 5 years of payments have been made on an original 30-year term mortgage that they have taken, it would only have 25 years remaining. Only the title changes on documents are necessary, not any change to the documentation itself.
Which Mortgages Can be Assumed?
There are a few types of loans that can be assumed during a sale of a home. Buyers can to take over or assume some federally insured or guaranteed mortgages. However, they cannot assume other kinds of mortgages for homes. Conventional loans cannot be assumed, for example. But buyers are able to assume:
- FHA Loans – guaranteed through the Federal Housing Administration. Federal Housing Administration.
- VA Loans – insured through the Department of Veterans Affairs. The borrower does not need active veteran status or part of the military.
- USDA – is backed by the Department of Agriculture.
If you are assuming a loan that has a lower interest rate than the current market interest rates, loan assumption can save you thousands in interest over the life of your loan.
The Advantages of Assumable Loans for Buyers
A lower interest rate is the main benefit of an assumable loan since it enables the buyer to obtain an interest rate that would otherwise not be available in the market.
These loans provide additional benefits. For instance, those with less-than-perfect credit may be able to qualify and still secure a mortgage at terms that are more favorable than many other lenders may offer.
Additionally, there can be significant savings associated with an FHA, USDA, or VA loan. Fees and closing costs associated with these types of loans are often lower than what comes standard on many conventional mortgages. An FHA loan may even give borrowers the option to add certain closing costs to their loan amount without having to raise their interest rate in return.
These advantages have made the FHA, USDA, and VA loans popular among homebuyers and people refinancing existing mortgages. It’s worth weighing these options when looking for a loan since they can provide some significant financial rewards. Of course, it’s important to make sure one meets all the qualifications and requirements for whichever type of loan is chosen before beginning the process of applying for it.
How to Assume a Mortgage
A mortgage assumption requires approval by both seller and buyer and the lender. Any informal agreement without informing the lender could pose risks that must be mitigated as soon as discovered by lenders; they could request payment of all outstanding amounts immediately, with the liability falling upon both. In cases where loans were held in the seller’s name alone, liability will lie solely with them for all outstanding obligations incurred during an assumption.
To be eligible for a loan, a new borrower must still qualify. When applying, lenders will request information on credit history, employment, and financial matters from both applicants before relieving the original borrower of responsibility for debt payments.
If a buyer assumes a mortgage balance of $300,000 on a house appraised at $500k, they’ll need to negotiate with the seller as to when and how they’ll make up the difference of $200k. The seller could demand all the cash up front, or they could work out another agreement where the seller carries back some of the difference between the sale price and the balance on the first mortgage.
Transactions may be completed directly between buyer, seller, and lender; however, you may find it beneficial to work with a real estate agent to negotiate the specifics, including the closing date and how any differences exist between property value and mortgage balance are addressed.
To be able to assume a mortgage, the lender needs to first grant you the green light. These are the steps you must follow:
- Check that the loan can be assumed – Make sure to confirm that the loan is assumable. It’s recommended to contact the lender who is currently the mortgage holder to make sure they’re willing to allow the assumption as well as ensure that the seller has been in compliance with their loan repayments.
- Be prepared for the expenses – the borrower will need to pay a down payment. The amount of the down payment is contingent on the amount of equity that is owned by the seller. After the assumption is approved, you’ll also need to cover closing costs, but they are usually lower if you are taking on a mortgage, compared to getting a loan in the conventional way.
- Send in your application – The process of assuming can differ from lender to lender. However, in general, you’ll need to complete an application as well as provide proof of income other documentation, along with proof of identification.
- Closing and signing a liability release – If the assumption is accepted, then you’ll have to sign the paperwork exactly like you would for closing any other kind of mortgage. This could include a release of liability, stating that the seller is no longer responsible for paying the loan.
Tip: How to Search for Assumable Loans
Ask your real estate agent to search “assumable mortgage” as a financing option. If searching yourself, see if your app lets you search keywords and use “assumable mortgage” as a keyword to see if any sellers offer it as a selling option. Also, look up pre-foreclosures (an artform in itself but a title company can help), reach out directly to the owners and ask whether they would consider letting you assume the mortgage as a way out from foreclosure.
Two Types of Assumable Loans
There are two kinds of mortgages that are assumable.
Simple Assumption
The first is called a “simple assumption”. This means that the buyer assumes responsibility for payments to the mortgage without the involvement of the lender.
Anyone can make a simple assumption using a private agreement. However, these agreements can be extremely risky.
The danger for the seller with a basic assumption is that the seller remains liable for the entire amount of the mortgage, even after the sale.
If the buyer goes into arrears in paying or breaches the terms of the mortgage, then the seller’s credit will be affected. If the lender finds out about the assumption, it could require that the mortgage balance be immediately paid in full according to a “due on sale” clause contained in most non-commercial loan agreements.
Simple assumptions are very rare except for family transactions. You might be willing to take this risk when the individual assuming your mortgage is your spouse, son, or daughter for instance. In most cases, an assumption of this kind isn’t safe enough to be practical.
Novation
Most assumable mortgages are “novations”. They need permission from the mortgage company, and buyers must undergo the same underwriting procedure as every other new borrower and will be accompanied by an evaluation of credit as well as financial documents.
The good thing about novation for the seller is they walk away from the assumption with no liability. What transpires with the loan following the transaction is solely with the borrower and lender.
Assuming a Mortgage After Death or Divorce
An assumption doesn’t always require the sale of a property. A family member may assume the existing mortgage of a deceased relative if they inherit the property. Or when one of the parties gets sole possession of a property as part of a divorce settlement or divorce proceedings, they can assume the entire mortgage by themselves. In both instances, it is possible to assume the mortgage even if the contract does not contain any assumption provisions. In the event of an inheritance, the borrower who is the successor is not required to be eligible for the loan to take it on.
Assumable Mortgage Pros
As a buyer, the benefits of assuming a mortgage loan in today’s market with higher interest rates are:
- Interest rate that is low. Rates are increasing. You could lock in a previous, lower interest rate. Saving thousands over the life of the loan.
- Limits on closing expenses. Capped closing costs. FHA, VA, and USDA set restrictions on closing costs if the mortgage is taken on. You probably won’t require an appraisal for your home.
- Save money with less time on the loan. In addition to locking in a lower interest rate, you’ll likely be borrowing for less time. If you are assuming a 30-year mortgage that has been in place for 10 years you will only have 20 years left on the mortgage. Your payments will immediately be going more to principal versus interest than if you were starting off with a new 30-year loan.
These advantages are powerful and can result in tens of thousands saved in interest costs over the life of the loan.
Assumable Mortgage Cons
For buyers, the drawbacks are usually:
- A larger down payment. The buyer might be required to come up with a large down payment if the seller has substantial equity.
- Insurance for mortgages. For FHA or USDA loans, the borrower will inherit any mortgage insurance premiums. These are mandatory on these kinds of mortgages.VA loans don’t have private mortgage insurance.
- Limited loan possibilities. Only certain types of mortgage loans are eligible to be assumed. For those with excellent credit and enough savings for a down payment, it may make more sense to obtain a conventional loan instead of searching for an existing loan that is assumable.
A higher down payment can be one of the major drawbacks to the assumption of a mortgage. The requirement for down payments will be contingent on the specific conditions of the loan you’re taking on, how much equity is in the property, and what you can negotiate with the seller.
You Can Use a Home Equity Loan to Pay for Your Down Payment
Another option for buyers to consider when purchasing a home with an assumable loan is to use the home equity to help with the down payment.
This would require that you take out a second loan in the same way that you took over the principal mortgage. In the future, you’ll be required to make two mortgage installments until the loan to your home equity is fully paid.
FHA, VA, and USDA loans permit second mortgages for the purchase of properties — a.k.a. subordinate finance. However, there’s no assurance. The lender could reject a second mortgage if they don’t agree with the conditions. Be sure to inform the lender that you’ll be getting subordinate financing and provide any supporting documents requested. They will want to be sure that total debt to income and total debt to equity meet their underwriting requirements.
Is the second mortgage strategy worth the effort?
It certainly could be. You’ll need to do some calculations. First, calculate how much you’ll save on your payments with the assumable first mortgage with a lower interest rate and lower balance due, in comparison to getting a new loan for the entire purchase amount at today’s interest rate. Then, calculate the payment for the equity loan. If the payment for the home equity loan is less than the difference between the total cost of getting a new loan today versus assuming the existing loan, this strategy may work for you.
Be aware that the second mortgage you take out will likely be from another lender other than the one which holds the mortgage you’re assuming. Therefore, you must work with the mortgage lender you currently have and be sure that they’re willing to cooperate.
Additionally, you’ll likely require at least a credit score of at least 680 to be eligible for the home equity loan.
Explanation of Types of Loans That Are Assumable:
What is an FHA Loan?
An FHA loan is an affordable loan option backed by the Federal Housing Authority for low to moderate income borrowers to qualify for the purchase and home-refinancing programs with a down payment as low as 3.5%. This type of loan has become increasingly popular in recent years, due to its lower credit score requirements, minimal down payment requirements, and generous terms such as no maximum income limitations, flexible credit requirements, and potential tax deductions.
FHA loans can be extremely beneficial to many individuals and families. They can allow people with limited resources to become homeowners or homeowners to refinance their current mortgage at a more advantageous rate. FHA loans are also much more forgiving for those with bad credit. According to the Consumer Financial Protection Bureau (CFPB), forty percent of all FHA loans require a credit score of 580 or lower compared to conventional loans which typically require 680 or higher.
FHA loans are an incredibly useful tool for people looking to purchase or refinance their current mortgage at a competitive rate regardless of their financial situation or credit score.
What is a USDA Loan?
USDA Loans are very attractive for potential homeowners due to the low-interest rates and other benefits it offers. A USDA Loan is a government loan that is backed by the United States Department of Agriculture and is intended to help lower-income individuals secure a home loan. This type of loan has favorable terms since it offers 100% financing, no down payment requirement, and lower mortgage insurance costs than what would be required with FHA loans. Additionally, there are income and purchase price limits depending on the state of residence.
The biggest difference between an FHA Loan and a USDA Loan is that with an FHA Loan, you typically need to put down a 3.5% deposit, while you don’t need to pay a deposit for a USDA Loan. Also, mortgage insurance premiums (MIPs) exist with FHA loans but can be more forgiving for low-income households when using a USDA Loan – this could make all the difference for families who would otherwise not qualify for conventional financing due to their income bracket. Additionally, an FHA loan typically requires more paperwork than a USDA loan does, making it more complicated for many potential homebuyers.
USDA Loans are an attractive option for those seeking low-interest rates on home loans without having to worry about putting down large deposits. With the attractive terms offered by these loans, lower-income households have more options when deciding how best to buy a home or refinance a loan.
What is a VA Loan?
Unlike a USDA loan, which is designed to help rural homeowners purchase a primary residence, VA loans are available to active duty or veteran members of the U.S. military and their surviving spouses, making it easier for military personnel to purchase a home without going through the normal credit check process. The main advantage of a VA loan is that there is no down payment required, so veterans can finance up to 100% of the cost of their new home without having to come up with a large sum of money upfront. Another benefit of a VA loan is that lenders are not allowed to charge origination fees or prepayment penalties, which can make it more affordable for borrowers. In addition, VA loans typically offer lower interest rates than other types of home loan products.
Though the lack of a down payment does make it easier for veterans and their families to purchase homes sooner rather than later, there are also some drawbacks to keep in mind; notably that borrowers will still need to pay private mortgage insurance (PMI) if they finance more than 80% of their home’s value. That said, while not everyone may qualify for a USDA loan due to location restrictions, VA loans are available nationwide and remain one of the most accessible options for veterans who want to purchase or refinance a home without high down payment.
A VA Loan can give qualified veterans access to great benefits they may not find elsewhere.
Frequently Asked Questions
If I permit the buyer to take over the mortgage on my behalf, will I need to be concerned that they’ll be late for payments and damage my credit score?
No. If the buyer takes over that mortgage, the seller is granted a novation (the lender replacing one contractual party for another) and you will not have an obligation to the mortgage. The loan will show the loan’s payment on the credit report of the seller the same way as if the buyer obtained their own loan. The answer is different if the buyer purchases “subject to” the existing loan. In that case, the existing loan remains in place, the buyer makes payments, but the seller is still on the hook with the lender.
Which loans can be assumed?
VA, FHA, and USDA loans.
If I assume a loan, can I let someone else assume my loan when I’m ready to sell?
Yes. There is no limit on the amount a mortgage can be assumed provided that the purchaser is eligible for the loan.
Can the seller provide a second mortgage on the property?
The seller may “carry back” the difference between what’s due on the first mortgage and the sale price. The lender of the main loan must approve use of a second mortgage, as well as the debt to income and debt to equity ratios after the first and second loans.
Do I have to pay Private Mortgage Insurance (PMI) when I assume a loan?
It depends. If the mortgage you are assuming includes mortgage insurance in the loan payment, then you will need to pay it. VA loans don’t have mortgage insurance.
Can a real estate investor assume an FHA, VA, or USDA loan?
Yes.
Does it take longer to assume a loan rather than to obtain a mortgage on my own?
No. Assuming a loan is a more efficient process than originating a new mortgage since the assumable loan is already secured and financed by the initial lender, and an appraisal has already taken place, which means it is less troublesome and is typically faster.
Contact Deepak Malhotra if you need help with real estate investing. Even if you are not looking in Cheney, Medical Lake, Airway Heights, or the Spokane area, mentoring services or referrals can be provided.