What Is an Assumable Mortgage?
An assumable mortgage is a type of financing arrangement whereby an outstanding mortgage and its terms are transferred from the current owner to a buyer. By assuming the previous owner's remaining debt, the buyer can avoid having to obtain their own mortgage.
- An assumable mortgage is an arrangement in where an outstanding mortgage and its terms can be transferred from the current owner to a buyer.
- When interest rates rise, an assumable mortgage is attractive to a buyer who takes on an existing loan that was secured with a lower interest rate.
- The only two types of loans that are assumable are loans insured by the Federal Housing Administration and the US Department of Veterans Affairs.
Understanding Assumable Mortgage
Many homebuyers typically take out a mortgage from a lending institution to finance the purchase of a home or property. The contractual agreement for repaying the property loan includes the interest that the borrower has to pay per month in addition to the principal repayments to the lender.
If the homeowner decides to sell their home at some time in the future, they may be able to transfer their mortgage to the homebuyer. In this case, the original mortgage taken out is assumable.
An assumable mortgage allows a homebuyer to the current principal balance, interest rate, repayment period, and any other contractual terms of the seller's mortgage. Rather than going through the rigorous process of obtaining a home loan from the bank, a buyer can take over an existing mortgage. There could be a cost-saving advantage in doing so if current interest rates are higher than the interest rate on the assumable loan.
In a period of rising interest rates, the cost of borrowing also increases. When this happens, borrowers will be face high-interest rates on any loans approved. Therefore, an assumable mortgage during this period is likely to have a lower interest rate reflecting the current state of the economy. If the assumable mortgage has a locked-in interest rate, it will not be impacted by rising interest rates.
An assumable mortgage is attractive to buyers when interest rates are rising. A seller's existing mortgage may have a lower locked-in interest rate than the current going rate.
Advantages and Disadvantages of Assumable Mortgages
The advantages of acquiring an assumable mortgage in a high-interest rate environment are limited to the amount of existing mortgage balance on the loan or the home equity. For example, if a buyer is purchasing a home for $250,000 and the seller's assumable mortgage only has a balance of $110,000, the buyer will need to make a down payment of $140,000 to cover the difference or the buyer will need a separate mortgage to secure the additional funds.
A disadvantage then is that if the home's purchase price exceeds the mortgage balance by a significant amount, the buyer may need to obtain a new mortgage. If this happens, the bank or lending institution may include a higher interest rate on the $140,000 mortgage depending on the buyer’s credit risk.
Usually, a buyer will take out a second mortgage on the existing mortgage balance if the seller’s home equity is high. The buyer may have to take out the second loan with a different lender from the seller’s lender, which could pose a problem if both lenders do not co-operate with each other or if the borrower defaults on both loans.
If the seller’s home equity is low, however, the assumable mortgage may be an attractive acquisition for the buyer. If the value of the home is $250,000 and the assumable mortgage balance is $210,000, the buyer need only put up $40,000. If the buyer has this amount in cash, they can pay the seller directly without having to secure another credit line.
Special Considerations for Assumable Mortgages
The final decision over whether an assumable mortgage can be transferred is not left to the buyer and seller. The lender of the original mortgage has to approve of the mortgage assumption before the deal can be signed off by either party. The homebuyer must apply for the assumable loan and meet the lender’s requirements, such as having sufficient assets and being creditworthy.
If approved, the title of the property is transferred to the buyer who makes the required monthly repayments to the bank. If the transfer is not approved by the lender, the seller has to find another buyer that is willing to assume his mortgage and has good credit.
A mortgage that has been assumed by a third party does not mean that the seller is relieved of the debt payment. The seller may be held liable for any defaults which, in turn, could affect their credit rating. To avoid this, the seller must release their liability in writing at the time of assumption, and the lender must approve the release request releasing the seller of all liabilities from the loan.
A seller is still responsible for any debt payments if the mortgage is assumed by a third party unless the lender approves a release request releasing the seller of all liabilities from the loan.
Conventional mortgages are not assumable. Two types of loans are assumable: FHA loans, which are insured by the Federal Housing Administration, and VA loans, which are guaranteed by the US Department of Veterans Affairs.