What are Assumable Mortgages? Everything You Need to Know
For most people, buying a home involves a down payment and getting a mortgage to pay for most of the purchase. When interest rates are low, borrowers have greater buying power. But rising interest rates make it harder for buyers to qualify for a loan, especially in areas where the cost of homes has grown. Alternative mortgage options can be essential for buyers facing difficulties getting mortgages and buying homes. With this information, buyers will better understand how an assumable mortgage works and whether it might be a good choice.
What Is an Assumable Mortgage?
An assumable mortgage is a mortgage that can effectively be transferred from one person to another. Not all mortgage types allow another borrower to assume the mortgage, particularly conventional loans. An assumable mortgage involves the complete sale of the home to the buyer. Instead of receiving a lump sum payment to settle the mortgage, the seller participates in a process to accept payment for their equity in the home and transfer the mortgage to a new borrower.
There are a few different assumable mortgages, and buyers should understand the differences before choosing one. The first is a simple assumption, wherein the buyer agrees to make the mortgage payments effectively on behalf of the seller. The lender is not involved in this process, which means that both seller and buyer remain responsible for the debt. This type is uncommon because it requires the seller to continue the loan. Novation is another assumable mortgage type wherein the lender plays a prominent role in determining whether the buyer can assume the mortgage.
What Types of Mortgages Are Assumable?
Mortgages that various government organizations guarantee often have a clause that allows someone to assume the mortgage. These government organizations include:
In many cases, buyers can assume these mortgages without paying for an appraisal or an additional down payment beyond the equity they must pay to the seller. In addition, these government-backed loans may limit the types of closing costs the buyers can be charged and the total amount. To assume the mortgage, buyers must meet the loan qualifications set by the agency. For example, assuming a VA loan would require the buyer to meet eligibility requirements related to military service.
Conventional loans are usually not assumable. As a general rule, conventional loans contain a clause that requires the seller to use the proceeds of the sale to settle the mortgage. The seller cannot transfer home ownership to another person without dropping the mortgage. Because the seller has to pay off the mortgage as part of the sale, it would be impossible to arrange for the buyer to assume the existing mortgage.
Pros of Assumable Mortgages
Assuming a mortgage instead of applying for a new one offers several benefits. These include:
- Lower interest rates
- Lower closing costs
- Smaller mortgage size
The ability to get a lower interest rate on an assumable mortgage depends on multiple factors, including the type of loan and the current mortgage rates. Someone who bought or refinanced a luxury home when interest rates were low could have a much more affordable mortgage than a loan that a new buyer could get now. Assuming that mortgage could provide long-term benefits over the life of the loan, mainly if it is a fixed-rate mortgage.
Although borrowers who assume a mortgage typically have to pay a larger down payment, they may not need to pay as much in other costs. Loans guaranteed by these agencies usually set closing cost limits, typically tied to a specific dollar amount. In exchange for a larger down payment than would be required for a new mortgage, borrowers have a smaller loan. For example, a borrower who assumes a mortgage that is half paid off could have a loan that is half the amount of a new one.
Cons of Assumable Mortgages
Although assumable mortgages offer several attractive benefits, there are potential disadvantages that borrowers should consider. These include:
- Higher down payments, which are sometimes significantly higher
- Fees for transferring the mortgage
- Mortgage insurance requirements
- Additional qualifications required by the agency
- Limited loan options
- Limited sellers willing to engage in the sale
When borrowers assume a mortgage, they essentially pay the seller's down payment and equity in the home. The down payment amount depends on the mortgage's existing amount and the home's sale price. If the seller has paid half of a $400,000 home (including the down payment), the buyer would be expected to come up with $200,000 as a down payment.
In addition to the higher down payment, buyers may find that looking for an assumable mortgage makes the home-buying process more difficult. Not all sellers are willing to go through the process of mortgage assumption, especially if it limits their ability to apply for the same type of loan. Sellers may expect something in exchange for the benefit provided to the buyer, such as a higher purchase price. Although assuming a mortgage may involve fewer closing costs, it could result in a higher monthly payment. Assumable mortgages often have insurance requirements that may not apply to conventional loans.
Mortgage Transfer Approval
In most cases, borrowers must get approval from the lender before they can assume a mortgage. A simple assumption could be possible in some instances, but most sellers are unwilling to continue to shoulder the financial responsibility for the mortgage. As such, borrowers who want to assume a mortgage of someone they do not know will probably have to take the route of novation. This means determining the lender's requirements, submitting documentation with proof of income, and waiting for underwriting to determine an answer.
Assumable mortgages have requirements, and they may come from multiple sources. These are not necessarily the same as the requirements to qualify for a new mortgage of the same type. For example, someone who applies for a new FHA loan typically needs to pay for an appraisal. To assume an FHA mortgage, however, the borrower may not. Lenders often charge fees to process an application to assume a mortgage, but it may not be the same as the fees they charge for a new mortgage. Homes in communities with membership fees and responsibilities, such as condos or gated community homes, may require additional applications.
Start Looking for Mortgage Options
Finding the right home often starts with getting the right mortgage, and buyers may have options they can consider. Rising interest rates translate to decreased buying power, making assumable mortgages an attractive alternative. Assumable mortgages allow buyers to lock in the same terms the seller has on the mortgage, but they usually have to make a much higher down payment to get it. Considering these factors will make it easier for buyers to evaluate their choices and decide on the loan option that works best for them.