Mortgage rates have gone well over 7% as we move into the last quarter of 2022, hitting a 20-year high. As a result, home buyers are looking for alternatives to get a lower rate and more affordable payments on their home purchases. One of those alternatives gaining popularity is assuming loans that the home seller currently has on their home. Let’s explore loan assumption facts and how buyers can use them when purchasing a home.
What Is a Mortgage Assumption?
A mortgage assumption is when a home buyer, or anyone taking ownership of the property, assumes all rights and responsibilities associated with the existing mortgage on the property. The party taking title to the property needs approval from the seller and the current mortgage holder to legally assume the mortgage.
Is It Legal to Assume a Mortgage?
It is perfectly legal to assume a mortgage if the current mortgage holder has received the required documents and approved the assumption.
A word of caution — in high-rate environments such as we have now, there are those touting purchasing homes “subject to” the existing financing. They may mention using “Land Contracts” or similar instruments to take title to the property and “take over” the existing mortgage. The practice of Land Contracts or “Subject to” home purchases is fraught with legal potholes. First, all mortgages have a “due on sale” clause, meaning the entire mortgage balance is due and payable when the property changes title. That is unless there is an assumption clause on the mortgage and all requirements to assume the mortgage are met.
What Are the Advantages of Assuming an Existing Mortgage?
This is the million-dollar question, of course. What’s in it for the buyer? The most obvious answer is naturally getting a lower rate than what they can get in today’s mortgage rate environment.
As we have crossed the 7% rates milestone, homes are becoming less and less affordable. Conversely, most homeowners who had a loan and saw the attractiveness of rates in the low 3 percent range refinanced their mortgage. If you find a home to buy and it happens to have an assumable loan in that range, you essentially can get a mortgage for less than half of what you would pay today. So you sort of.. hit the jackpot!
In addition to a lower rate and payment, you also pay quite a bit less in closing costs. You won’t have to pay points, funding fees, etc. In the end, your mortgage-related costs should be about 75% lower than if you took out a new mortgage. That’s a nice little bonus.
What Are the Disadvantages of Assuming an Existing Mortgage?
As with anything else in life, there are pros and there are cons to most things. As attractive as it is to be able to assume a mortgage, there are two primary downsides to assuming a mortgage.
First, it is not simple to find the circumstance where a home you happen to like will have a loan you can assume. You may have to compromise a bit and settle for a home you may “learn to love” as a result of having a great deal on the assumable mortgage.
Second, you will probably need much more cash to buy a home with an assumable mortgage than if you were to take out a new mortgage.
Most homes with an existing mortgage will have equity in excess of 10% or 20%, which means you have to make up the difference between the sales price and the current mortgage. The assumption opportunity is ideal for people with large down payments, such as those that are currently selling a home and realizing a sizable profit.
Additionally, you can explore a “seller carry-back,” where the seller holds a 2nd mortgage to cover the gap between your downpayment and the equity needed. For example, a $400,000 purchase with a $250,000 existing FHA loan would need a down payment of $150,000 from the buyer. However, the seller can carry a note for $120,000, and the buyer would only need a $30,000 down payment.
What Types of Mortgages Are Assumable?
One of the biggest hurdles to assuming a mortgage is finding a home with an assumable mortgage. There are three assumable types of loans: FHA, VA, and USDA.
FHA Loans are assumable by any buyer who qualifies for the mortgage. Be prepared to go through the same process as if you were taking out a new loan. The lender will check the credit report, run the debt-to-income qualification analysis, etc.
VA Loans as also assumable by anyone who qualifies for the mortgage. It is not necessary that the buyer be a veteran. The buyer also has to fully qualify for the loan as if they were taking out a new loan, except they don’t have to be veterans.
USDA Loans are also available to buyers who qualify for the existing mortgage. When assuming a USDA loan, the income limit requirements must also be met in addition to the regular loan assumption requirements.
What Are the Costs of Assuming a Mortgage?
Every lender has its own fee policy for assuming a loan. However, there are limits on the fees they can charge.
For FHA loans, the maximum a lender can charge is $900 in lender fees. This excludes other costs related to a home purchase, such as escrow and title fees.
VA loan fees include a .5% VA funding fee and a lender fee that is limited to $300 maximum, plus credit report fees. These fees do not include other closing costs related to buying a home, such as title and escrow fees.
USDA loan assumption fees vary by lender and are usually less than $500. One of the big advantages of assuming a USDA loan vs. taking out a new loan is that buyers assuming the mortgage will not have to pay the 1% upfront funding fee that is payable on new USDA mortgages.
What Is the Liability to the Seller When Letting a Buyer Assume Their Mortgage?
With FHA and USDA loans, the assumption process releases the seller of liability connected with the loan. The buyer becomes the official new mortgagor, and they are 100% responsible for the outcome of the performance of the mortgage.
With VA loans, the seller needs to be aware of a couple of additional matters. The most important is their VA entitlement. If the seller is letting a non-veteran buyer assume the VA loan, the seller’s VA entitlement will be tied to the existing mortgage, and the seller will not be able to use a VA loan to buy another home in the future using the VA eligibility.
If the buyer is a veteran, the seller can request that the buyer substitute their VA entitlement and release the seller’s VA entitlement so the seller can use it in the future.
Additionally, sellers should ensure that the VA loan assumption includes a full release of liability as part of the assumption process. This will release the seller from repercussions if the new buyer defaults on the mortgage.
Summing It Up
We are not in the ideal situation in terms of mortgage rates right now. Sellers and buyers are starting to feel the strain of higher rates.
Assuming existing loans will not be a solution for everyone, but if you happen to come across the right opportunity, it is a perfect way to beat today’s rates and secure a mortgage you can live with for years to come, and secure a home you may not be able to buy otherwise.
Related Reading: Assumable Mortgages Aren’t Outdated Options