An assumable loan is when a buyer may take over, or assume, from a seller. Assuming a mortgage is not an easy process, and it is not always possible, but it is possible to benefit from such a loan.
An assumable mortgage allows you to assume the repayment period, interest rate, current balance and all other terms of the seller's existing mortgage, rather than getting a brand-new loan. While any mortgage can be assumable in theory, only two types of common loans allow this: FHA loans and VA loans. In general, conventional loans are not assumable.
In the right situation, assuming a mortgage can be easier and less expensive for the buyer than getting a new loan.
Same Qualifications Apply
Qualifying to take over an assumable mortgage works the same as obtaining a new mortgage. The lender will run a credit check and make sure the borrower can afford the monthly payments based on debt and income levels.
Payment to Seller Replaces Down Payment
When a buyer gets a new mortgage, they must pay a down payment of 3.5% to 20% or more to the bank to get the loan. When assuming a mortgage, there is no down payment, but instead a payment must be made to the seller to compensate for the equity the owner has built.
Full Cost of Loan May Not Be Covered
Another unique aspect of assuming a loan is the mortgage may not fully cover the cost of the home and may require a down payment or additional financing, on top of a payment to the seller for equity.
If the seller has an assumable mortgage of $100,000 but is selling the home for $125,000, the buyer must come up with the extra $25,000 somehow. The rest of the cost may be borrowed at the current higher rate.
Liability Release for the Seller
The seller also enjoys an advantage with an assumable mortgage, as the home may be more desirable to buyers if the loan has a low rate and the seller has very little equity that must be paid by the buyer. The catch to this is the seller may still be responsible for the debt once the new buyer assumes the loan if the lender does not release the original borrower from the loan.
VA Entitlement in an Assumable Loan
VA loans have always been assumable, in large part because military members often relocate. VA loans are associated with a veteran's entitlement, however, which means the seller's entitlement will remain attached to the loan if the buyer is not a veteran or does not have entitlement. This can prevent the seller from using this entitlement to obtain a new home loan. If the entitlement remains with the assumed loan and the buyer defaults, the seller may not be able to use the entitlement again without a heavy cost.
When is an Assumable Loan a Good Deal?
Buyers gain the biggest advantage when the terms of the seller's loan are more attractive than prevailing terms at the time. The interest rate is most important, but other factors also play an important role. If interest rates are on the rise or current rates are much higher than the rate on the seller's mortgage, it may be a smart move to assume the mortgage, when possible.
It is also important to consider how much must be paid to the seller for their equity. In general, assuming a mortgage is a good deal when the buyer does not pay more than 10% to 20% of the purchase price in cash and when the interest rate is lower than current rates.