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An assumable mortgage is a loan that can be transferred from one party to another with the initial terms remaining in place. For buyers and sellers in a rising interest rate environment, taking advantage of an assumable mortgage is a great option that makes financial sense—if done properly.
- What is an Assumable Mortgage?
- Which Mortgage Loans are Assumable?
- How to Assume a Mortgage
- Tips for Home Loan Assumptions
- When Does it Make Sense to Transfer a Mortgage?
What is an Assumable Mortgage?
An assumable mortgage allows another party to take over the remaining payments on a mortgage loan, while keeping the existing loan rate, repayment period, principal balance and other terms intact. The rights and obligations of the original loan are essentially ported from one borrower to another without a new mortgage being created. The buyer agrees to make all subsequent loan payments going forward, as if they took out the original loan.
Not all loans are assumable, however, and the lender must approve the assumption in most cases. Similar to a standard purchase mortgage, whether your assumption is approved will depend on your ability to qualify for the loan and your ability to repay your debts. There are generally two types of mortgage loan assumptions:
A Simple Assumption is where the buyer takes over on the mortgage payments from the seller. This is a private transaction where title to the home passes from the seller to the buyer, and requires less involvement from the lender. This process is inherently risky for the seller, as they remain liable for payments on the original debt. A simple assumption places the seller in the position of a secondary obligee, similar to a mortgage co-signer. Although the buyer agrees to make payments on the home loan during a simple assumption, the seller still remains responsible for the mortgage. Any delinquencies or defaults incurred by the buyer will also appear on the credit report of the the seller.
Novation is where the buyer takes over on the payments for the mortgage, and the lender formally assigns all rights and responsibilities of the original mortgage to the buyer. Following novation, the original borrower is released from all liability and a new obligation is created with the same terms and interest rate of the old loan. The existing loan is therefore, both assumed by another party and assigned to that party by the lender or loan servicer. Novation agreements are more desirable because they eliminate liability for the original borrower, and result in the full transfer of the mortgage to the new homebuyer. These are generally a cleaner solution than simple assumptions.
Which Mortgage Loans Are Assumable?
Government-backed loans, like FHA, VA and USDA loans, will generally allow for assumptions. They typically don’t include the "due on sale" clauses that would prevent the loan from being assumed. The "due-on-sale" clause was popularized for conventional loans in the ‘70s and ‘80s due to changes in lending practices. If you see a "due on sale" clause in your mortgage contract, you may be out of luck as far as loan assumptions go, although it never hurts to ask the lender directly.
Are FHA Loans Assumable?
FHA loans made after Dec. 1, 1986 are assumable, but require that the lender verify the creditworthiness of the buyer in order to qualify. This means meeting current FHA underwriting guidelines for income, assets and credit:
- You will need a minimum credit score of 580, though individual lenders can have a higher score requirement.
- Your debt ratios should not exceed 31% for your housing expenses and 41% for your total monthly expenses.
Are USDA Loans Assumable?
USDA loans are usually assumable, but require the prior approval of the USDA. They will not grant an approval if the seller is behind or in default on their payments. In order to qualify:
- You will need a minimum credit score of 580 to 620, depending on individual lender guidelines.
- Your household income cannot exceed 115% of the average median income for the area.
- Your debt ratios should not exceed 29% for your housing expenses and 41% for your total monthly expenses.
Are VA Loans Assumable?
VA loans are assumable because they serve a specific purpose for current and former military members. The Veterans Administration backs their loans with a guaranty, otherwise known as an "entitlement," and each serviceman or woman has a certain amount of entitlement available to them. Basic entitlement is $36,000, and the VA guarantees up to four times the entitlement amount, or $144,000, of the loan against default. This acts as protection for the lender, especially if the homeowner is required to move as part of their military service.
If a serviceman or woman is required to move quickly on orders, for example, they may not have enough time to sell their house, restore their entitlement and purchase a new home fast enough. If another eligible veteran is able to assume their loan, then their entitlement is restored and they can use their VA benefit again in the future. Keep in mind, both the VA and the current lender have to approve the assumption. Additionally, if a non-veteran assumes the loan, the entitlement will not be restored.
Are Conventional Mortgage Loans Assumable?
Conventional loans are not typically assumable because they almost always contain a "due on sale" clause in their loan documents, requiring that the mortgage be paid off if the property is transferred. Virtually all mortgage loans originated in recent years incorporate a due-on-sale clause; this is standard operating procedure for most major banks and credit unions.
There may be exceptions with some private lenders, as there is no legal requirement to include the due-on-sale clause in loan documents. The removal of the due-on-sale clause may also be subject to negotiation when seller-based financing is involved. There are also situations where you can transfer a mortgage without triggering the due-on-sale clause; these will typically involve the transfer of real estate through a trust or inheritance, or as part of a divorce. It's always a good idea to consult with your real estate attorney to confirm the legality and feasibility of such transfers.
How to Assume a Mortgage
To assume a mortgage loan, you must check whether your lender will permit an assumption, and if so, whether you qualify for the assumption. If assumption is allowed, the qualification requirements will be similar to those of a standard mortgage application.
1) Find Out If the Loan is Assumable
You can check the loan documents to see whether assumptions are permitted. The loan document will typically state whether or not the loan is assumable under the "assumption clause." The terms may also appear under the "due on sale clause" if loan assumption isn't permitted. If the documents don't contain these terms, you should contact the lender directly and ask them to confirm whether the loan is assumable.
You can also refer to page 4 of the Closing Disclosure if the loan was made after the Dodd-Frank Act regulatory changes. The subheading may read as follows:
"Assumption - If you sell or transfer this property to another person, your lender
- Will allow, under certain conditions, this person to assume this loan on the original terms.
- Will not allow assumption of this loan on the original terms."
2) Send the Assumption Request to the Lender
You will need to send the assumption request to the lender as well as the corresponding government entity that guarantees your mortgage. It’s likely that they will both charge fees for this service. The maximum allowable fees for FHA and VA loan assumptions are listed below:
- FHA loan: $500
- VA loan: $300 and a 0.5% funding fee (paid by either the buyer or the seller)
The lender may also charge its own separate fee. Typically, this ranges between $800 and $1,000—but it could be as much as 1% of the loan amount.
3) Submit Personal Financial Information for Review
Depending on the type of loan you are trying to assume, the lender may require income, asset and credit information to determine your ability to qualify for the existing loan. They are obligated to verify your ability to repay the mortgage, just as they did with the original borrower. Certain programs allow for reduced documentation, however, so consult with the lender to find out exactly what information they’ll need to review.
4) Sign the Assumption Agreement/Modify the Deed
The most important document in the loan assumption process is the deed of trust, which adds your name to the mortgage and absolves the original borrower of any obligations under the agreement, assuming a novation.
All parties will be required to sign the final documents. The deed, coupled with the mortgage note, is recorded at the County Recorder’s Office and finalizes the process of securing the buyer’s obligation and releasing the seller’s obligation.
Having an owner’s title insurance policy created is an added level of security for the buyer, and a title company along with an escrow agency can assist with coordinating documents and processing the recording. For complex situations, it may be in everyone’s best interest to consult with a real estate attorney.
Tips for Home Loan Assumptions
It’s important to ensure that the lender has signed off on the assumption, because they determine who is ultimately responsible for payment on the loan. Until the seller is released from liability by the lender, they are responsible for the debt, and nonpayment by the would-be assumer of the loan could negatively impact their credit score.
It's also important to accurately value the property before assuming the loan. While an appraisal isn’t required as part of the assumption process, you’ll want to have one done anyway to ensure you're not overpaying for the property. Additionally, a title search should be performed to make sure there aren’t any liens or other encumbrances outstanding on the property that fall outside the scope of the mortgage. These would need to be addressed before assuming the loan.
When Does it Make Sense to Transfer a Mortgage?
If the terms of the seller’s existing mortgage are more favorable than what’s available in the current market, then assuming the loan could be financially advantageous. In a rising rate environment, buyers can secure better terms by assuming loans that were originated in periods of low interest rates. As rates continue to rise, it's likely that rising rates will continue to make loan assumptions more attractive.
A loan assumption might also make sense after any major event that requires the transfer of property. This can include divorces, estate planning and inheritances, gifts of real estate, or other non-arm’s length transactions. You may wish to consult an attorney to confirm whether an assumption would be permitted in any of these scenarios. FHA, USDA and VA loans also usually permit assumptions without the actual sale of the property.
Another advantage of having an assumable loan is that it can serve as an incentive for homebuyers, especially if the existing interest rate is low and the terms are particularly good. This can be used as an added selling point if you encounter a buyer who's willing to make a significant cash contribution.