An assumable mortgage allows the purchaser of a property to assume the mortgage from the property's seller. There may be benefits for both the buyer and the seller attached to an assumed mortgage. However, everything depends on the buyer possessing the capacity to take on the assumed mortgage rate, which often is lower than prevailing market rates. Additionally, an assumable mortgage helps the purchaser avoid certain settlement costs. Generally, loans made during the last 20 years of a mortgage are rarely assumable with the notable exception of VA and FHA loans.
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The buyer is not the only party to benefit from an assumable mortgage. The seller shares in the arbitrage by either charging a higher price for the property, requiring the purchaser to pay the closing costs that the seller may incur, or demanding cash payment for one-half of the buyer's savings over an agreed-upon time frame.
For example, if the current interest rate is 8%, the assumable mortgage rate is 5%, and the buyer plans to live in the home for five years, the seller might demand half of the often-undiscounted expected savings for the five-year period. In such a case, the assumable mortgage may benefit the seller even more than the buyer!
Here are some of the advantages and disadvantages of assumed mortgages for both buyers and sellers.
- If the assumable interest rate is lower than current market rates, the buyer saves money straight away.
- There are also fewer closing costs associated with assuming a mortgage. This can save money for the seller as well as the buyer. If the buyer is gaining a lower interest rate, the seller may find it easier to negotiate a price closer to the fair market asking price.
- The seller may also benefit from using the assumable mortgage as a marketing strategy to attract buyers. Not all mortgages are assumable, and the seller could get the upper hand over the market competition.
- A buyer who assumes a mortgage may require a large amount of cash or to take out a second mortgage. If the home is valued at a price greater than the mortgage that remains on the home, the buyer must make up the difference. A home might be on the market for $350,000, but the mortgage to be assumed is only $200,000. The buyer will need to contribute $150,000.
- A second mortgage is problematic because there are two mortgage lenders involved and the contractual details are complex in cases where the buyer defaults. Moreover, assuming another loan negates the benefits of the assumable loan.
Finally, VA and FHA loans may be assumed provided the buyer receives credit approval from the mortgage lender. This contingency is not placed on the lender, who agrees that the loan may be assumed but, rather, it is a way for the lender to determine if the buyer is credit-worthy. In such cases, the seller will not receive any of the arbitrage profits, but the buyer must pay additional fees to the VA or FHA.