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Here’s What to Know About Mortgage Assumption

As a homebuyer, you typically get a brand-new mortgage to finance your home purchase, and the home seller may use proceeds from your loan to pay off their mortgage. In some cases, though, you can take on a seller’s remaining mortgage debt rather than borrowing a new loan through mortgage assumption. Let’s explore how assumable mortgages work in more detail.

What is mortgage assumption?

Mortgage assumption is the process of one borrower taking over, or assuming, another borrower’s existing home loan. When you’re assuming a loan, the outstanding balance, mortgage interest rate, repayment period and other terms attached to that loan often don’t change.

An assumable mortgage might make sense for a home seller who is finding it difficult to attract potential homebuyers, or for a buyer who is being priced out of the housing market due to higher rates.

“Imagine if somebody’s got [a 3.25% rate] and interest rates move to 5.5% or 6%, what an incentive [assuming a loan] might be,” said Michael Becker, a branch manager with Sierra Pacific Mortgage in Lutherville, Md.

How does mortgage assumption work?

The assumable mortgage applies only to the balance remaining on the original loan and may not cover the home’s current value. As a buyer, you’re responsible for making up the difference by either paying cash out of pocket or taking out a second mortgage, such as a home equity loan.

For example, if the seller has a $200,000 loan balance on a $300,000 home, you’d need to bring $100,000 to the table to compensate the seller for the equity they’ve built.

If you’re financing the difference between the assumable mortgage and the home price, you’d need to find a lender who’s willing to qualify you for a second mortgage and ensure you’re meeting combined loan-to-value (LTV) ratio guidelines for your loan program, Becker said.

There are two primary types of mortgage assumption: simple assumption and novation.

Simple assumption

A simple assumption mortgage is a private transaction between a home seller and homebuyer. The buyer takes the title to the home and assumes responsibility for the seller’s mortgage payments. This arrangement may not involve loan underwriting.

The seller is still liable for the outstanding mortgage debt, so if the buyer makes late payments or goes into default, the credit profiles of both the buyer and seller are affected.

Novation

Novation involves a mortgage lender and the transfer of all rights and responsibilities of the existing loan from the seller to the buyer. The lender releases the seller from all liability on the loan and begins to hold the new homebuyer liable for repayment.

For the lender to agree to a novation, though, the buyer must meet lending requirements.

Which loans are eligible for mortgage assumption?

In most cases, government-backed loans — from the Federal Housing Administration (FHA), U.S. Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA) — may qualify for mortgage assumption. Conventional loans allow loan assumption under limited circumstances.

Conventional loans

Conventional mortgages generally don’t permit loan assumption, since they often include a “due-on-sale” clause. This clause permits a mortgage lender to declare the outstanding loan balance due and payable if that loan is sold or transferred without the lender’s consent.

A lender can’t legally exercise the due-on-sale clause under a handful of circumstances, such as a parent passing away and leaving their home to you in their will, or in a divorce. The exceptions to the due-on-sale clause usually involve a transfer of ownership between relatives, rather than a third-party homebuyer looking to assume a mortgage.

Fannie Mae, one of the two agencies that buy and sell mortgages from lenders, does permit loan assumption for standard adjustable-rate mortgages (ARMs) — for borrowers who meet credit and income requirements — in one of two ways. Either the ARM is:

  • Assumable during the entire loan term, or
  • Due on sale during the fixed-rate period and assumable once the adjustable-rate period begins.

If you have a conventional ARM, reach out to your lender to determine whether mortgage assumption is allowed and how to qualify.

FHA loans

All FHA loans are assumable, according to the U.S. Department of Housing and Urban Development (HUD), which oversees the program.

FHA lenders are required to review the creditworthiness of the prospective borrower who wishes to assume an existing FHA loan. The rule applies to loans originated on or after Dec. 15, 1989. There are exceptions to the credit approval rule, including the original homeowner’s death (resulting in the home being gifted to an heir) or the original homeowner retaining an ownership interest in the property.

However, be aware that the rules for FHA assumable mortgages have changed over time.

VA loans

VA loans are assumable, but there are stipulations for certain loans that don’t exist for others.

VA loans originated after March 1, 1988, require prior approval before a lender will allow assumption. The buyer must meet credit and income qualifications. Loans originated before that date are “freely assumable,” meaning that a homebuyer can assume the mortgage without prior approval from the VA or a VA-approved lender. However, if the seller wants to be released from liability on the loan, the buyer must qualify to assume the loan.

The VA allows unrestricted mortgage assumptions when there’s a divorce or death. Learn more about assuming a VA loan.

USDA loans

The USDA permits mortgage assumption and has two different types: “new rates and terms” and “same rates and terms.”

  • New rates and terms assumption. The homebuyer assumes the seller’s outstanding loan balance, but the loan is re-amortized with a new interest rate and loan terms. Most USDA loan assumptions fall under this category.
  • Same rates and terms assumption. The homebuyer assumes the seller’s outstanding loan balance with the same interest rate and existing amortization schedule. The USDA allows this type of loan assumption in limited situations, including death or divorce.

Pros and cons of an assumable mortgage

Before you decide on mortgage assumption, review the benefits and drawbacks.

Pros

  • You could lock in a lower-than-average mortgage rate, depending on when the loan was originated.
  • You might pay less in closing costs, since standard underwriting isn’t involved.
  • Your mortgage amount is likely to be smaller than if you took out a new loan.

Cons

  • Your “down payment” may be significantly higher than if you were taking out a new mortgage, as you’ll need to cover the seller’s equity.
  • You’ll need to meet credit and income requirements to release the seller from liability on the loan.
  • You may be charged a loan assumption fee on top of your closing costs. For example, FHA lenders can charge buyers up to $900 for assuming a loan.

How to qualify for mortgage assumption

Unless you’re assuming a loan from a relative, you generally must qualify for mortgage assumption — once the home seller confirms they have an assumable loan. Generally speaking, the buyer must meet the same credit and income requirements applicable to a brand-new loan.

“You’re not going to let somebody assume a loan who doesn’t have any money in the bank, doesn’t have a job and has a terrible credit score,” Becker said.

The table below lists qualifying guidelines for an assumable mortgage under conventional and government-backed programs.

Conventional loans  FHA loans  VA loans  USDA loans 
Minimum credit score  620 500 620* 640*
Maximum debt-to-income ratio  45%* 43%* 41%* 41%*

*May qualify with a slightly lower credit score or higher DTI ratio, depending on compensating factors. 

Check with your lender for more details on qualifying for an assumable loan.

 

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