The process of buying a home usually involves applying for a new mortgage loan with a financial institution. But in some cases, buyers may be able to get a loan without starting from scratch.
That’s what happens with an assumable mortgage, which enables borrowers to take over the existing mortgage on the home they’re buying. The new buyer takes full liability for the loan, meaning the seller is off the hook.
This type of loan is often used in markets where mortgage interest rates are relatively high. Buyers can get a lower interest rate than the current market rate by taking over someone else’s mortgage. While this sounds like a great deal, only select mortgages are eligible for this type of mortgage, and they come with a few catches.
What Is an Assumable Mortgage?
An assumable mortgage is a way of financing a home in which the buyer takes over the loan from the existing owner. The new borrower assumes the existing mortgage exactly as it is, with the same remaining balance, interest rate, and repayment terms.
When a homebuyer assumes a mortgage, they’re responsible for funding the difference between the remaining loan balance and the home’s current value. Suppose a homeowner was selling their home for its current market value of $250,000 but had a remaining mortgage balance of $200,000 — the buyer would have to cover the remaining $50,000.
Which Mortgages Are Assumable?
It’s important to note that not all mortgages are assumable. If you’re considering this type of financing, be sure to verify you have the right type of loan.
Loans that are assumable include FHA loans, VA loans, and USDA loans, according to Anthony Grech, senior mortgage loan originator at Luxury Mortgage Corp. “Your typical conventional fixed-rate loans don’t usually have assumability features,” says Grech.
When Is an Assumable Mortgage Used?
Assumable mortgages allow homebuyers to take over an existing mortgage with its current interest rate and term. As a result, assumable mortgages become more popular when interest rates are high.
During the week of February 22, the average rate on a 30-year fixed-rate mortgage was 3.04%, a very low level in historical terms. Now imagine that a few years down the road, mortgage rates might rise again. Rather than taking out a new mortgage, a future borrower might assume a mortgage from someone who borrowed when rates were low, therefore locking in that low rate for themselves.
“Depending on how the next four years go, we could definitely see a situation where rates are headed in an upward direction,” Grech says. “If rates are double what they are now, I would think we’d see these more often.”
So what savings might make this type of mortgage worth it?
“Three-quarters of a point,” says Nicole Rueth, branch manager at Fairway Independent Mortgage Corporation in Englewood, Colorado. “There’s not a science to that, it’s an art. A quarter-point might be worth it, but somehow that three-quarters of a point seems to be the tipping point.”
In other words, homeowners might opt to assume someone else’s mortgage rather than applying for a new one if the existing loan has an interest rate three-quarters of a point below the current market rate. as interest rates increase, so does the likelihood of someone choosing an assumable mortgage.
How To Qualify for an Assumable Mortgage Loan
Qualifying for an assumable loan is very similar to qualifying for any other FHA, VA, or USDA loan.
Borrowers “qualify to assume a loan just like you would qualify to get the loan on their own,” Grech says. “You still have to be qualified from a credit and ability to pay standpoint.” This means that assuming a mortgage is “not a way for people who don’t qualify for a mortgage to suddenly get a home.”
The parties can move forward with the loan assumption only if the lender finds the buyer to be eligible for the loan.
This wasn’t always the case. Before the late 1980s, the buyer wouldn’t necessarily need to qualify for a mortgage. The home’s seller and buyer would privately agree to the mortgage assumption without the buyer having to prove their creditworthiness.
“Assumable mortgages have changed dramatically from what most people remember them as,” said Bill Wilson, senior vice president of a Fairway Independent Mortgage Corporation branch in Las Vegas. “Thirty or 40 years ago, an assumable mortgage was non-qualifying. You go and buy Bob’s house, and the bank had no say in it. Now borrowers have to go and qualify just like any other mortgage.”
How Much It Costs to Assume a Mortgage
The cost of an assumable mortgage is often lower than the closing costs buyers would pay for conventional loans, according to Wilson.
“The assumption cost is usually a couple hundred dollar charge, which would be low compared to the fees someone would pay to set up a new loan,” Wilson says.
Part of what helps to keep assumable mortgage costs low is that there are caps on how much lenders can charge. In the case of FHA loans, the Department of Housing and Urban Development prohibits lenders from charging more than the mortgagee’s actual costs. The maximum fee a lender can charge is $500.
If you’re considering an assumable mortgage, make sure you understand your upfront costs. Depending on the remaining loan balance and the home’s current value, you could be on the hook for a large down payment.
Pros and Cons of Assumable Mortgages
Assumable mortgages can be an effective way of taking advantage of a low interest rate, but they aren’t suitable for everyone. Let’s talk about some of the arguments for and against this type of loan.
Lower interest rate
Lower closing costs
Only available on certain loans
Possibly large down payment
Pro: Lower Interest Rate
The primary reason that someone might use an assumable mortgage rate is to take advantage of a lower interest rate when market rates are high.
Mortgage rates are near all-time lows, and future borrowers may not have access to such favorable terms. By assuming a mortgage rather than taking out a new one, buyers may be able to get a rate significantly lower than the market would otherwise allow.
Pro: Lower Closing Costs
Assumable mortgages come with lower closing costs, and the government agencies that insure them place caps on how much loan services can charge in fees. As a result, buyers may have lower upfront costs than they would taking out a new mortgage.
Con: Only Available on Certain Loans
Assumable mortgages are only available in the case of certain government-backed loans. These loans come with limitations that you wouldn’t find with a conventional loan.
“If I qualify for a conventional loan, I might not want to do it,” Rueth says. “I might want to go ahead and purchase it with a conventional mortgage.”
Con: Large Down Payment
One of the greatest challenges with assumable mortgages is that they often require a large down payment or creative financing to come up with one. When you assume someone else’s mortgage, you have to make the seller whole. If their home is worth $300,000, but they only have a remaining principal mortgage balance of $200,000, the buyer must come up with the remaining $100,000 as a down payment.
According to Wilson, some borrowers may find other ways to finance the difference, such as using a home equity line of credit. But the problem with this arrangement is that payments can eventually become unaffordable.
Home equity loans or lines of credit often have a 10-15 year drawdown period when borrowers are only paying interest. But once that drawdown period ends, borrowers must start paying their principal down and may see their payments increase dramatically.
“When that loan goes to fully amortizing, you’re going to have a payment shock situation,” Wilson says. Borrowers may not be “expecting their payment to suddenly jump $800-$900 per month.”
Is an Assumable Mortgage a Good Idea?
There are both pros and cons to assumable mortgages, which may not be right for everyone.
“I would say the same thing that I would say to almost anyone looking for a particular mortgage,” Rueth says. “The first question I ask is, Why? Why is that the loan you’re asking for? A lot of times it’s because someone told them.”
You should do your research and make sure that an assumable mortgage works for you in your financial situation, Rueth advises.
An assumable mortgage allows a homebuyer to take over — or assume — the seller’s mortgage rather than taking out a new mortgage. Assumable mortgages can be an effective way to take advantage of an interest rate that’s lower than the current market allows.
But assumable mortgages aren’t for everyone. They’re only available on certain government-backed loans and come with other potential ramifications that could make them cost-prohibitive.