What is an Assumption Clause
An assumption clause is a provision in a mortgage contract which allows the seller of a home to pass responsibility for the existing mortgage on to the buyer of the property. In other words, the new homeowner assumes the existing mortgage. The new buyer must typically meet credit and other qualifications.
BREAKING DOWN Assumption Clause
If the interest rate on an existing mortgage is lower than current market rates, an assumption clause becomes an attractive selling point. Also, the buyer can avoid many closing costs although there are typically some fees involved in the transaction. Some of the costs will include a title search, document stamps, and taxes.
For most homeowners, the benefits of an assumption clause are theoretical since conventional mortgages generally prohibit the practice. Banks frown on the practice because they write mortgages based on the creditworthiness of the original borrower, not an unknown later buyer. The new owner's ability to repay may be challenging to evaluate, and the bank may be reluctant to take on their risk. Moreover, even if a bank were to approve the creditworthiness of a new borrower, it would lose out on the down payment and closing costs incurred with a brand-new mortgage. Also, it is probable that current market interest rates are higher than the rates on the original note.
As it is rarely in a bank’s interest to allow assumptions, most mortgages include a due-on-sale clause which demands repayment of the remaining balance when the property sells. The bank will not sign off on its lien until the mortgage is repaid, making the sale essentially impossible.
However, assumption clauses are standard in government-backed mortgages from the Federal Housing Administration (FHA), the Veterans Administration (VA), and the U.S. Department of Agriculture (USDA). The new owner must still meet credit and eligibility standards. These government-backed mortgages account for nearly 20-percent of all U.S. mortgages.
How Does an Assumption Clause Work?
Imagine a person wants to assume the mortgage from a seller who has a 30-year, $240,000 mortgage at 3.5-percent on which they have made payments for five years. The remaining balance, including interest, is about $323,300, and there are 25 years remaining on the original note. Assume the current market interest rate is at 4%. Had the new buyer taken out a 30-year fixed-rate mortgage for the same $240,000 loan, it would make the balance, with interest, due at the end of that time of about $412,500. Also, the new buyer would need to submit a lump-sum down payment to the financing institution.
By assuming the seller’s existing mortgage, the buyer would save about $89,000 over the term of the loan. Also, there are five fewer years of payment obligation with the assumption clause loan. Any lump sum payment would be given to the seller to offset equity they have built up in the home. Plus the buyer will avoid thousands of dollars in closing costs.