Want a low mortgage rate? Take someone else’s. Learn below on how assuming an existing mortgage can result in a lower mortgage rate and substantial savings when purchasing a home.
What is an Assumable Mortgage?
An assumable mortgage is a workaround that can help some homebuyers struggling to purchase a home in a rough housing market with high interest rates.
Assumable mortgages are loans that allow a homebuyer to take over a seller’s existing mortgage. A buyer keeps the seller’s repayment period, mortgage balance and, notably, the seller’s mortgage rate. This can be particularly advantageous in certain market conditions, offering both buyers and sellers unique benefits. When a mortgage is assumed, it saves the buyer time and money, especially if the interest rate on the existing mortgage is lower than current market rates.
Types of Assumable Mortgages
About 12.2 million US mortgages are assumable, according to data from Intercontinental Exchange. That amounts to 23% of all US mortgages. Within that group, 14%, or 7.2 million, have interest rates under 4%.
Not all mortgages are assumable. The most common types of assumable mortgages include:
Federal Housing Administration (FHA) Loans: FHA loans are insured by the government and are generally easier to assume than conventional loans. They have lower down payment requirements and more flexible credit standards.
Veterans Affairs (VA) Loans: VA loans are available to veterans and active-duty military members. These loans can also be assumed, even by buyers who are not veterans, although certain conditions must be met.
United States Department of Agriculture (USDA) Loans: USDA loans, designed for rural property buyers, can also be assumed. These loans are intended to support homeownership in less densely populated areas.
Conventional loans, on the other hand, are typically not assumable unless explicitly stated in the loan agreement. Most conventional loans contain a "due-on-sale" clause, which requires the loan to be paid in full if the property is sold or transferred.
The number of FHA-backed loans assumed grew 111% between 2021 and 2023, while the number of VA-backed loans assumed grew 713% in that same time period. An assumable loan must be approved by the seller’s lender and the VA, FHA, or other government agency backing the loan. A homebuyer must also meet specific credit and income standards before getting approval.
Advantages of Assuming a Mortgage
Lower Interest Rates: One of the primary benefits of assuming a mortgage is the potential to secure a lower interest rate. If the seller’s mortgage has a lower rate than what is currently available, the buyer can save significantly over the life of the loan.
Reduced Closing Costs: Assumable mortgages can result in lower closing costs since some fees associated with originating a new loan can be avoided.
Simplified Approval Process: For FHA, VA, and USDA loans, the approval process for assuming a mortgage can be less stringent compared to obtaining a new loan, especially for buyers with less-than-perfect credit. And for a seller, allowing a buyer to assume a mortgage can facilitate a quicker sale, if time is of the essence.
Equity Advantage: Buyers can gain immediate equity if the property has appreciated in value since the original mortgage was issued. This can be particularly beneficial in a rising real estate market.
Disadvantages of Assuming a Mortgage
Qualification Requirements: While the process can be simpler, buyers must still qualify to assume the mortgage. Lenders will evaluate the buyer’s creditworthiness and financial stability, which can be a barrier for some buyers.
Down Payment: The buyer must cover the difference between the home's purchase price and the remaining balance on the assumed mortgage. If the seller has built up significant equity, this can require a substantial down payment. A buyer may have to obtain a second mortgage to pay the seller the amount of equity accumulated in the seller’s home if cash isn’t readily available.
Possible Delay: Loan assumptions can take a considerably amount of time to close, delaying a seller’s purchase of their next home, or a buyer being able to move. A lender essentially treats the assumption process similarly to a new loan application, which can be time-consuming, reviewing the buyer's financial situation, credit history, and ability to make mortgage payments. Also, a lender often requires a new appraisal and home inspection to confirm the current value and condition of the property.
Restriction of Future VA Loans: Passing your mortgage along to a civilian may delay your ability to get approved for another VA loan in the future. Veterans can also lose their entitlement if a foreclosure or short sale occurs. A veteran’s entitlement to purchase a home can be tied up until the loan is fully repaid. An entitlement is how much the Department of Veterans Affairs will guarantee to repay lenders, typically $36,000 or 25% of the loan amount, in case the borrower defaults and helps determine how much a veteran can borrow before needing a down payment. If a veteran must buy a replacement home, entitlements will be reduced or restricted for that purchase because of what's tied up in the first property.
Release of Liability: It’s imperative for the seller to obtain a formal release of liability on the mortgage from their lender. If the lender does not release the seller, the seller could remain liable if the buyer defaults on the loan.
Due-on-Sale Clause: Conventional mortgages typically have a due-on-sale clause, which can prevent the mortgage from being assumed. Buyers must be cautious and verify that the mortgage they intend to assume is indeed assumable.
Example of an Ideal Circumstance for Assuming a Mortgage
Consider a scenario where a buyer, Justine, is looking to purchase a home in a market where interest rates have recently risen to 6%. She finds a property listed by a seller, Kevin, who has an FHA loan with an interest rate of 3.5%. Kevin purchased the home five years ago and has a remaining mortgage balance of $200,000.
The home is currently valued at $300,000, meaning Justine would need to cover the difference of $100,000 as a down payment. Assuming the mortgage, Justine would benefit from the lower interest rate, saving her thousands of dollars in interest payments over the life of the loan. If we were to calculate Justine’s monthly mortgage payment on a new $200,000 mortgage at 6% interest, her monthly payment would be approximately $1,199 (excluding taxes and insurance). By assuming Kevin’s mortgage at 3.5%, her monthly payment would be about $898. This results in a monthly saving of $301, totaling $3,612 annually. Over a 30-year term, Justine could save over $108,000 in interest payments. Typical closing costs for a new mortgage can range from 2% to 5% of the loan amount, which for a $200,000 loan could be $4,000 to $10,000. By assuming Kevin’s mortgage, Justine may only need to pay a fraction of these costs, further enhancing her savings. In addition, the simplified approval process for the FHA loan is another advantage, as Justine’s credit score is average, and qualifying for a new loan at the current market rates could be challenging.
Summary
Assumable mortgages offer a unique opportunity for buyers and sellers to navigate the complexities of the real estate market. For buyers, the potential to secure lower interest rates, reduce closing costs, and benefit from simplified approval processes can make assuming a mortgage a great alternative. Sellers can leverage assumable mortgages to facilitate quicker sales and potentially achieve better terms.
However, it is essential for both parties to thoroughly understand the qualifications, financial implications, and potential risks involved. Buyers must be prepared to cover any necessary down payment and meet the lender’s requirements, while sellers must ensure they are released from liability to avoid future financial obligations.
In an ever-changing real estate landscape, assumable mortgages represent a valuable strategy that, when used wisely, can create win-win scenarios for both buyers and sellers.
LaShawn Freeman, Douglas Elliman Real Estate Agent
Unlocking new memories, one door at a time.
M: 917.254.3313 / E: lashawn.freeman@elliman.com
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