Interest rates are one of the biggest challenges that homebuyers face in the current market. With climbing rates, monthly mortgage payments are skyrocketing compared to what they were just a few years ago.
Many people are sitting on the sideline hoping that rates drop, but what if you didn’t have to wait?
Mortgage assumption offers a cost-effective solution for buyers who want to purchase a home now. Leveraging an assumable mortgage may help decrease your monthly mortgage payment sinificantly. This article gives you everything you need to know.
What is an Assumable Mortgage?
Mortgage assumption is a creative financing method for buyers to take advantage of and save big time on their monthly payment. An assumable mortgage is when you take over the seller’s current mortgage. The buyer gets to keep the seller’s:
- Interest rates
- Monthly payments
- Remaining balance on the loan
In short, you pick up the seller’s mortgage right where it left off. There’s also very little difference between an assumable mortgage transaction and a conventional mortgage transaction. Real estate agents still represent both parties, there are closing costs involved, and the buyer ultimately gets full ownership of the property.
With interest rates well above 7%, assuming a mortgage is how you get to turn back the clock to get lower interest rates from the past. To illustrate this point, let’s take a look at this assumable mortgage home listing in Atlanta:
As you can see, the interest rate makes a huge difference. A $425,000 home at today’s interest rate makes the monthly payment about $2,700. In contrast, assuming the existing mortgage puts your monthly payment at $1,370.
Effectively, you could cut your mortgage in half by buying a property with an assumable mortgage.How would your life be different with $1,330 more in your bank account every month? That’s the difference an assumable loan assumption makes.
Learn how you can cut your monthly payments in half with Roam.
Mortgage Assumptions are not the Same as Subject-To Agreements
In a subject-to transaction, the homebuyer takes over the property but the seller retains the mortgage. The buyer makes mortgage payments for the seller.
On the other hand, in a mortgage assumption, the seller’s name is removed from the mortgage note and the buyer takes their place. The seller no longer has any liability of the mortgage subsequently, and the mortgage is now completely in the buyer’s name.
A mortgage assumption concludes the relationship at the sale and is the least risky long-term choice for all parties involved.
How Do Assumable Mortgages Work?
Assumable mortgages take the place of originating a brand-new loan. The seller’s remaining mortgage balance is used to cover a portion of the purchase price. To put this into more practical terms, let’s look at this step-by-step example following the illustration below.
Identify the equity
To determine how much you will need as a downpayment, you need to know how much equity the seller has in the property. Equity is the difference between what the property is worth ($500,000 in this example) and what the seller still owes ($400,000).
$500,000 (list price) – $400,000 (remaining balance) = $100,000 (down payment)
The down payment buys out the homeowner’s equity and the mortgage transfers to the new borrower. To do this, you will need to come to closing with $100,000.
Come up with a down payment
The most straightforward way to come up with the funds for this is to tap into existing savings. But, what if you don’t have the full amount in savings?
You can take out a second mortgage or “second lien mortgage” to cover any gap in the seller’s equity you can’t cover with your own down payment. Second lien lenders typically have a requirement where you can only borrow 80% of the value of the property. This is called loan-to-value or LTV ratio.
In this scenario, the buyer needs to come up with $200,000 for a downpayment. They have $100,000 in cash, but still need an additional $100,000 in order to assume the loan. To do this, they take out a second mortgage where they borrow the difference from a bank.
It’s important to note that although second mortgages also come with a higher interest rate, the blended interest rate with an assumed original mortgage still usually results in a lower interest rate than taking out a brand new mortgage.
What Types of Mortgages are Assumable?
By law, FHA loans, VA loans, and USDA loans are assumable types of loans. It’s important to note that not all mortgages are assumable, although we’re actively working at Roam to figure out how to make conventional loans assumable, which is the biggest chunk of US mortgages. We know how gamechanger that would be for the real estate industry, home buyers, and home sellers.
Who can assume a mortgage? What are the eligibility requirements? Anyone can assume given they meet the credit and income requirements of the mortgage lender and the stipulations of the specific type of assumable loan.
FHA Loans
Fun fact: all FHA-insured mortgages are assumable.
An FHA mortgage is a Federal Housing Administration loan. In short, it’s a government backed mortgage that comes with insurance to protect lenders against potential losses and defaults. There’s FHA loans for first-time homebuyers with friendly loan terms that usually include a fixed rate. It can be a smooth path to homeownership.
There are a couple of nuances in regards to origination dates of the FHA loans that impact their assumability. Mortgages originated before 12/1/1984 generally have no restrictions on assumability. Those originated after 12/1/1986 will require a creditworthiness review of the person taking over the assumable mortgage.
Learn more about FHA loans from the Department of Housing and Urban Development.
VA Loans
VA loan is short for Veteran Affairs loan. It’s a mortgage backed by the U.S. Department of Veteran Affairs and is offered as a benefit to qualified borrowers who’ve been in the military.
For all VA loans committed after 3/1/1988, the loan may be assumed by anyone as long as the lender or VA approves the creditworthiness of the new homebuyer.
You don’t have to be a veteran or military-affiliated at all to assume a VA loan. However, some VA loan holders may not want non-military buyers to assume their loan because they will lose their VA-loan entitlement if the buyer isn’t military affiliated. Losing a VA-loan entitlement is a big deal because it means losing out on the VA helping repay your future home loans.
USDA Loans
USDA loans are U.S. Department of Agriculture loans. USDA loans are specifically for rural property owners. This makes it appealing to buy outside of big cities where millions are flocking to.
There are two scenarios for assuming a USDA loan:
- Same Rates and Terms Assumption: in limited cases, generally involving transfer of title between family members, the buyer assumes the existing note terms
- New Rates and Terms Assumption: the purchaser assumes responsibility of the remaining debt, which is reamortized at new rates and terms.
Conventional Loans
Conventional loans come from private financial institutions as opposed to the government. While the majority of conventional loans are not assumable, some are. These vary by lender, and the terms and conditions of their assumability are also determined by each specific lender and may differ greatly from place to place.
Learn more about Conventional Loans.
Pros and Cons of Assumable Mortgages
Assumable mortgages offer tremendous upside, but it’s important to understand both sides of the argument. These are the biggest points for and against assumable mortgages. It’s up to you to decide whether the pros outweigh the cons:
Pros
- Lower interest rates. With interest rates playing a crucial role in the affordability of a home, this advantage can make homeownership more accessible and financially sustainable.This gives you additional buying power compared to others seeking a conventional mortgage at today’s rates.
- Save money over time. Your monthly payments will be lower, which means you’ll have more disposable income for other necessities. Over the life of the loan, you’ll also spend far less on interest paid. For example, the early years of your mortgage is when you pay more towards interest than your principal balance. At a lower interest rate, it will take less time to shift towards paying more towards your principal, which helps you build more wealth through home equity.
- Lower closing costs. Assuming a mortgage can often result in lower closing costs compared to obtaining a new mortgage. This is because the buyer doesn’t need to go through the full mortgage application and approval process, which can involve application fees, appraisal fees, and other closing costs. When the average closing costs range from 2% to 5% of the purchase price, these savings add up quickly.
Cons
- Larger down payments. Buyers must have enough cash on hand to cash out the seller’s equity. This amount must be covered in full either through an all-cash down payment, or by taking out a second mortgage. If they have $50,000 in equity, you’ll need to come to closing with this as your down payment. Luckily, Roam works with lenders who offer second mortgages to help you cover the down payment.
- Private Mortgage Insurance (PMI) for the life of the loan. PMI is a monthly fee that lenders charge to protect them against default. It is typically required when the buyer’s down payment is less than 20% of the home’s purchase price. On FHA and other government loans, PMI exists for the life of the loan. Even with PMI, it may be cheaper to assume a low interest loan than get a mortgage at today’s rates.
- Not every mortgage is assumable. Buyers must know where to look and how to identify suitable assumable mortgages. This can be a challenge for those new to the real estate market or unfamiliar with the process. The key is knowing where to find assumable mortgages.
How Do I Assume a Mortgage?
If you’re ready to embark on your journey to find an assumable mortgage, the first step is crucial. Understanding the process and knowing where to begin can make a significant difference in your home buying experience.
After you identify a home with an assumable mortgage, you’ll need to start working with the seller and lender.
As the potential buyer, you must meet the lender’s qualification criteria. This typically involves demonstrating your creditworthiness and financial stability. The lender will assess your ability to make mortgage payments. Terms will vary by lender and loan type, so you’ll need to have some upfront conversations to see if an assumable mortgage is the right path for you.
Ready to Find an Assumable Mortgage? How to Get Started
Like anything new, it takes time to learn the ins-and-outs of the process. We specialize in assisting homebuyers with assumable mortgages every step of the way. Our expert team is here to guide you through the process, answer your questions, and ensure a smooth and successful transition to your new home.
