Assumable Mortgage 101: The Basics
Most buyers have to take out a mortgage in order to pay for a home purchase. While taking out a new mortgage with a lender is the more common approach to take, there’s another option: taking over the seller’s mortgage.
It’s called an ‘assumable mortgage’, and it’s named so because the buyer essentially ‘assumes’ the seller’s home loan. Rather than applying for a new mortgage from the lender, the buyer assumes the interest rate, current principal balance, repayment period, and all other terms of the existing mortgage. The buyer then promises to make all future payments on the mortgage, just as they would had they taken out an original loan.
Of course, the lender needs to approve such a scenario before the seller’s mortgage can be assumed by the buyer. While this arrangement might not be right for everyone, it can be beneficial for both parties in many circumstances. Assuming an existing mortgage can be easier and more affordable for the buyer compared to applying for a new mortgage.
Why Would Buyers Assume an Existing Mortgage?
One of the biggest reasons why buyers would consider taking over a seller’s mortgage is to benefit from a low interest rate. If current home loan rates are a lot higher than what the seller is currently paying on the existing mortgage, there’s plenty of money to be saved on interest payments. Even if rates are currently low, the buyer may not be able to secure a low rate based an unfavorable credit score.
Buyers can also save plenty of money on closing costs with an assumed mortgage. There are typically a lot of closing costs involved in a real estate transaction. For instance, no appraisals are needed, which typically cost a few hundred dollars. By assuming a seller’s mortgage, closing costs like these can be significantly reduced, which means less money needed to close the deal.
Why Would Sellers Agree to Allow Buyers Assume Their Mortgage?
Considering the fact that there are fewer closing costs involved with an assumed mortgage, the seller can also benefit by potentially getting as close to the asking price as possible. After all, the buyer is saving a lot of money through cheaper closing costs and a lower interest rate.
Sellers can also advertise the potential for an assumable mortgage at a favorable interest rate as part of the overall marketing strategy to sell the home. Since not all mortgages are able to be assumed, it could help the seller stand out from the competition.
Potential Drawbacks of an Assumable Mortgage
Before buyers decide to take over a seller’s mortgage, they will first need to find out if the entire price of the home will be covered by the assumable mortgage, and whether or not a down payment or additional financing will be required.
For instance, if the seller has an assumable mortgage of $200,000, and the home is being sold for $300,000, the buyer must come up with the additional $100,000. The remaining cost of the home will need to be borrowed from a lender at the current market rate, which will likely be higher than the one on the assumed mortgage, unless the buyer can come up with the rest in cash.
If another loan needs to be taken out, the two mortgage lenders will have to contend with each other. Many times different lenders won’t want to cooperate, and for good reason. If the buyer is delinquent on one mortgage, that could be a real problem for the other lender. The benefit of an assumable mortgage is also significantly reduced if the buyer has to take out another mortgage to make up the difference.
For sellers, a potential drawback may be the potential risk of being held liable for the loan even after it’s been assumed. In this case, if the buyer defaults on the mortgage, the seller could be left responsible for the amount that the lender could not recoup. However, sellers can effectively avoid this risk by releasing their liability in writing when the assumption takes place.
It should also be noted that the majority of conventional loans typically cannot be assumed simply because many banks don’t allow it. On the other hand, Federal Housing Administration (FHA) and Veterans Affairs (VA) home loans can be assumed.
The Bottom Line
An assumable mortgage can make sense, depending on the type of mortgage, the difference in interest rates, and the disparity between the purchase price and the amount of the assumed mortgage. Before you consider going this route, you’ll need to chat with your lender to see if it’s even possible. If it is, make sure all the numbers add up, and you’re not putting yourself in a financially vulnerable position.
