4-min read
Many homebuyers have been put off by the relatively high interest rates of the past few years. What’s one way to avoid those high rates on a home purchase? Find a seller with a lower interest rate and assume their mortgage. This may sound outlandish, but 23% of active mortgages – or 11.6 million loans – are currently “assumable.”
Let’s explore what that means.
An assumable mortgage is a type of home loan in which an outstanding mortgage and its terms are transferred from one person to another without any changes to the original agreement.
This type of arrangement is commonly used in a divorce or with an inheritance, where one party assumes responsibility for a mortgage that may have been previously held by a former spouse or family member. It can also be an advantage in situations where interest rates are higher than they were at the time of the original purchase. By assuming the previous owner’s mortgage, the buyer can take on their lower interest rate, too.
It’s important to note that not all mortgages are assumable. And if they are, the buyer may need to pay the seller for any equity accumulated in the home, which can be considerable.
Most government-backed mortgages are assumable, including those issued by the Federal Housing Administration (FHA), Veterans Affairs (VA) and U.S. Department of Agriculture (USDA). In most cases, conventional (or private) loans are not assumable.
The process of assuming a mortgage is comparable to getting a new home loan, but there are some differences. Here’s an overview of how to assume a mortgage:
When a buyer assumes a mortgage, they avoid having to go through the process of obtaining a new home loan. Instead, they keep the seller’s mortgage, including the principal balance, repayment period and interest rate. And, again, when interest rates are high, assuming a mortgage can be a more affordable option for buyers.
For example, if the original owner has 27 years left on a 30-year mortgage with a fixed interest rate of three percent, the next owner will take over payments on that same mortgage.
One downside to assuming someone’s mortgage is that the loan you’re taking on may not be large enough to cover the home’s current market value. That could leave you responsible for paying the difference.
Say, for example, that the current owner purchased their house a decade ago for $300,000. They paid $10,000 down and took out an FHA loan for $290,000. They have since paid the loan down to $230,000. But now, due to the run-up in real estate prices, the home is worth $500,000 ($270,000 more than the mortgage balance). As the buyer, you will only assume the $230,000 remaining on the mortgage. So, you will still be on the hook for the $270,000 difference and would need to put down cash or take out a second mortgage to cover it.
If you have two mortgages, you’ll need both lenders to cooperate on granting the terms of service. This isn’t always possible and can result in defaulting. You may also need to obtain loan insurance – which, with FHA loans, can be significant.
Assumable mortgages can have drawbacks for sellers, too. The seller may remain legally responsible for the mortgage even after the sale, unless the lender specifically releases them from the obligation.
And, in the case of VA loans, the seller might have to give up their right to an “entitlement,” which is the guarantee that the Department of Veterans Affairs makes good to the lender if you default on your mortgage. In many cases, this entitlement allows veterans to purchase homes with zero percent down.
(If you assume a VA loan, the interest rate typically remains unchanged, but you may need to pay a funding fee to the VA loan program.)
If you, as the seller, sell your home to another veteran, you can ask them to formally substitute their entitlement for yours on the mortgage. But if you sell to a civilian, you may lose access to all or part of your entitlement on future home purchases.
Equal Housing Lender
