Let me tell you all a little story about mortgages. Long, long ago interest rates were extremely high, reaching nearly 19 percent in the early 1980s. At the same time, there were also assumable mortgages: a loan product that allowed a buyer to take over the loan on a home with the terms remaining intact.
This might not sound like much, but let’s say you were trying to buy a home in 1981 and were facing a new mortgage with a 19 percent interest rate. If you happen to come across a home for sale that was originally purchased with an assumable mortgage in the mid-1970s, the 9 to 11 percent interest rate it was carrying probably looked pretty good in comparison.
And so it went, with people buying the loan with their homes in more cases than not, making the assumable mortgage a pretty popular loan feature for a while. Rates dropped steadily from 1984 onward, making the concept of an assumable mortgage all but a footnote in real estate history.
With today’s historically low interest rates, it would seem ridiculous to even consider an assumable mortgage as a sales advantage, but these loans are due for a comeback. The decisions you make about your new mortgage today may well affect what happens with your home down the line: remember, those who can’t learn from history are doomed to repeat it.
What is an Assumable Mortgage?
When you have an assumable mortgage, it simply means you have a special feature on your loan — just like no prepayment penalty or ultra low mortgage insurance. There’s no such thing as an assumable mortgage that’s independent of another loan type, but certain loan types are much more likely to provide assumption options.
When you sell your home to a borrower who would assume your mortgage, you’re essentially giving them written permission to take over your payments and your note. The terms you agreed to when you first purchased the home still apply and the principal you’ve paid down is still going to be paid down. In fact, your buyer will pick up at the exact same place on the amortization schedule as where you left off.
As far as the bank’s concerned, it’s as if you’re still making your regular payments, except that someone else is footing the bill. In exchange for your awesome mortgage terms, the buyer will provide you with a cash sum to compensate you for any updates you’ve made, your home’s value grown by inflation and the principal you’ve paid down. It’s a pretty good deal all around, honestly.
Now, the bad news. Not all mortgages are assumable — and you probably never gave this a second thought when you secured your current note. That’s okay, you didn’t know better, but you do now. As long as mortgage rates are this epically low and you plan to stay in your home a few years, always ask your lender about an assumable option on your note. If you happened to purchase using an FHA or VA product, your loan is almost always automatically assumable.
The Benefits of Assumable Mortgages
Whether you’re a buyer or a seller, there are a number of ways that an assumable mortgage can benefit you, including:
Increased Marketability for Your Home. To be fair, this is only going to apply if you’re selling in a market much different from the one we’re currently experiencing, but rates were double where they are just a decade ago. If you can offer a potential buyer the option to take over a 4 percent mortgage when 8 or 9 percent is the norm, your home is going to get a lot of attention. After all, everybody loves a bargain.
Immediate Savings for the Buyer. Of course, if you’re the buyer and you’re picking up a house with an assumable mortgage whose interest rate can’t be touched by the finance companies around you, there will always be some immediate savings. Let’s say you’re assuming a mortgage five years into a note that was originally $200,000 with a 4 percent interest rate. 25 years and $181.245.70 will still remain in principal when you take over the note.
If you pay that note off completely, without any extra payments, you’ll have paid $105,553.80 in interest — that sounds like a lot, but when compared to the hypothetical interest rate of 8 percent, it’s really not much. To pay that same $200,000 note off in full at 8 percent, you’ll cough up $326,977.16 in interest. In a crazy world, where you could just skip the first five years of payments (so we can compare apples to apples), you’d still have paid $250,119.03 in interest at 8 percent during the last 25 years of a new note.
To frame it another way, your principal and interest payment on an assumed 4 percent note is just $954.83, where at 8 percent, you’re paying $1,467.53. That’s a $512.70 difference each and every month you pay on your note. You’ll pay $6,152.40 extra every single year.
|New Note||Assumed Note||Difference|
|Monthly P&I Payment||$1,467.53||$954.83||$512.70|
|Yearly P&I Payment||$17,610.36||$11,457.96||$6,152.40|
|Interest Paid in Final 25 Years of Note||$250,119.03||$105,553.80||$144,565.23|
Assumed Mortgage vs. New Mortgage (Original $200,000 note assumed at beginning of year five)
A Shorter Loan Term for the Buyer. Along with that smaller interest rate, you’ll also be inheriting a loan that’s partially paid off. The seller will have to tell you the exact details, but whether that’s two years or ten years, a shorter mortgage is still a great deal for you. Your home won’t be encumbered for as long, but you’ll still get to pay a low payment that was calculated using a 30 year amortization.
An Easier Deal for Everyone. Because an assumable mortgage requires a great deal less paperwork and hassle, they can close faster and cheaper than many other loan types. Most won’t require a new appraisal, since the amortization and loan amounts were determined with the original buyer. The paperwork is also minimal, cutting a lot of the cost of closing out of the final figures.
How Assumptions Work
In the future, when you may find yourself selling a home with an assumable mortgage (or buying one!), the process of assuming a mortgage isn’t likely to be much different than it is today. For that reason, we’ll talk about today’s procedure and hope for the best, since we can’t see what’s coming from that far down the road anyway.
When you assume a mortgage, you still have to qualify for it — just like the seller did. That means that assuming a mortgage is still not an option for someone with poor credit history or some other mortgage hurdle. The main benefit to assuming a mortgage is the money savings we discussed above. Of the two main types of assumable mortgages, the one you’re most likely to be able to assume is an FHA. VAs can be assumed by civilians if they were closed before March 1, 1988, but generally and reasonably speaking, only veterans or spouses of veterans can assume these products.
The bank or lending program (remember, some conventionals can be assumed) will have new stipulations for the new borrower that are very similar to the ones you had in the beginning of your loan. If the lender has special requirements, they tend to be occupancy or income restrictions, but check with your lender before you agree to the assumption so you know you won’t be in violation of your mortgage terms.
When you’re the seller of an assumable mortgage, you’ll want to make sure your bank gives you a release of liability form. This piece of paper ensures that if the new buyer defaults on their note, the bank won’t come back to you for the balance. This is typically something the title company closing your deal will catch, but mistakes do happen and this one could haunt you for years — so better to be safe than sorry.
The Bottom Line: Assumable Mortgages are the Next Big Thing
I don’t mean to be a doomsayer, but let’s all face a little reality: mortgage rates are going up. Maybe not much, and maybe not today, but soon. Over time these days of 4 percent mortgages will seem like some long ago dream that we’ll never see again in our lifetimes. That’s not all bad — I mean, the whole reason we got 4 percent mortgages in the first place was because the housing market was spiraling downward and threatening to take the whole economy with it.
Higher interest rates actually mean that the economy is stabilizing, that housing sectors aren’t stagnant and there’s a lot of churn in the market again. These are very good things — and although it might not seem like it now — great reasons for higher interest rates. Those are great big YAYS!
If you’re buying a home today, these future rates and circumstances may not mean a whole lot to you right now, but they should. Long term purchases like real estate should be made with an eye to the future (I’m sure I’ve told you this before) and there’s no single thing you can do to help your home’s future sales potential like buying with an assumable mortgage.
One day not terribly far from this one, mark my words, people will be clamoring to assume your 4 percent mortgage. When that day comes, you can be the guy with the assumable option on your note or the guy who didn’t think it would matter and is left out in the cold. Your call.