With assumed mortgages, it’s entirely possible to take on a “used” home loan. But is it a good idea?
Compromises are necessary in life, and the homebuying process is no exception. So when you find a home for sale in San Diego, CA, that checks all of your must-have boxes, it’s often a good idea to compromise on the easy-to-change design elements like wall color or carpeting that the seller’s leaving behind. But what about their mortgage terms? With an assumable mortgage, that’s precisely what you agree to: taking over and paying down the balance of the previous owner’s home loan, according to the original terms.
In a rising-interest-rate environment, an assumable mortgage might seem like an attractive choice. Landing a locked-in interest rate lower than what the current market is dictating could drastically lower the total amount you pay for your home. But buyers choose an assumable mortgage for other reasons too. Here’s what you need to know before deciding if this unusual option is right for you.
1. Only certain loan types are eligible for an assumable mortgage
Thanks to stricter regulations and a changing mortgage economy, assumable mortgages are less common now. And while some conventional loans do come equipped with an assumable-mortgage clause, most are Federal Housing Administration (FHA) and Veterans Affairs (VA) loans. Loan documents should indicate whether a loan is assumable.
2. Loan type and date matter
The process to assume an FHA loan is determined by the date of the original loan. If it was originated before December 1, 1986, it can be completed under the “Simple Assumption process,” with no required credit check or lender approval. If the original loan was originated on or after December 1, 1986, it falls under the “Creditworthiness Assumption process.” This means the potential buyer must qualify as they would for a new FHA loan and receive lender approval.
Assuming a VA loan requires the new buyer to have the income and credit to qualify for the loan. In addition, a fee equal to 0.5% of the existing principal balance must be paid by either the original owner or the buyer, depending on the agreement. For loans originated after March 1, 1988, both the VA and the lender must sign off on the assumption.
3. Not all mortgage environments are equal
One of the biggest perks of taking on an assumable mortgage is the ability to secure terms that are hard to come by in the current economy. However, with interest rates hovering at or near historic lows for some time now, the chances of securing a rate any lower than what’s being offered today could be challenging. In this case, other pros and cons would need to be considered.
4. Some upsides to consider for buyers and sellers
In the case of an assumable mortgage, the buyer has to pay upfront for the amount of equity the original owner has in the home. If the owner has little equity, this could mean a lower upfront cost for the buyer. Depending on the lender’s terms, closing costs could potentially be avoided with an assumable mortgage, and buyers may be able to skirt the appraisal requirement as well. In addition, if a buyer is taking on an assumable VA loan, they could receive the optimal terms without actually being a veteran.
Sellers could benefit as well. For a seller with excellent mortgage terms, having an assumable mortgage could be an added selling point. In some cases, this perk might even allow the seller to charge more for a home or have the upper hand to negotiate for the buyer to pay any closing costs. Plus, if a seller is currently struggling to make payments and their credit is suffering, this could potentially release them from their mortgage without the damaging effects of foreclosure.
5. There are downsides too
As with anything, downsides to assumed mortgages certainly exist — for buyers and for sellers. If a seller has a large amount of equity in their home, the buyer would be required to have that in cash upfront or take on the additional burden of a second mortgage. Another potential downside for the buyer could be the requirement to stick with the original loan’s lender. If the lender doesn’t offer approval, the deal can’t proceed.
Sellers can encounter big problems if they don’t receive a release of liability from the loan. Whether this is because it’s not explicitly stated in the paperwork or the mortgage is assumed “under the table” without lender approval, skipping this important step could leave the seller on the hook if the buyer defaults on the loan. In the case of VA loans, if a buyer doesn’t have VA entitlement (the government’s backing for the loan up to a certain amount), the owner’s entitlement will remain with the original loan. This means the original owner wouldn’t be able to use that entitlement on any other home loan until the original loan is paid off. Talk about a huge downside for the seller.
Think you can benefit from an assumable mortgage? Determine whether the deciding factors align in your favor before signing on the dotted line. After all, taking on a bad mortgage is probably more costly (and more permanent) than living with the previous owner’s poor choice in carpeting or wallpaper.