Did you know one of the ways you can finance a home purchase is to buy assuming the seller’s mortgage loan? It’s true, and it’s called an assumable mortgage.
Here’s a look at mortgage assumptions. Use it as a guide to help determine if it’s the best option to help you reach your financial goals.
What is an assumable mortgage?
Investopedia defines an assumable mortgage as “a type of financing arrangement whereby an outstanding mortgage and its terms are transferred from the current owner to a buyer.”
In short, an assumable mortgage allows a buyer to assume the seller’s mortgage after paying the difference between the home price and the mortgage balance. The buyer takes on all contractual terms of the seller’s loan. This includes assuming the seller’s monthly payments, principal balance, mortgage rate, and the repayment period.
An assumable mortgage can be a cost-saving solution for homebuyers when interest rates rise.
However, not all types of mortgages are assumable. Many conventional mortgages and adjustable-rate mortgages are not assumable unless particular qualifications are met, like divorce or death.
Types of assumable loans
Three types of loans are assumable, and they’re all backed by the federal government. Loans insured by the Federal Housing Administration (FHA), Department of Veteran Affairs (VA), or the United States Department of Agriculture (USDA) are assumable if specific requirements are met. Let’s take a closer look at how these assumable mortgages work.
FHA loans
FHA loans are issued by private lenders but insured and regulated by the Federal Housing Administration. The FHA is part of the United States Department of Housing and Urban Development. As a result, these loans may sometimes be called HUD loans.
FHA loans are easier to obtain than conventional loans because they don’t require a large down payment or a high credit score. FHA loans only require a 3.5% down payment and a minimum credit score of 580.
Here are the criteria that must be met to assume an FHA loan:
- The homeowner or seller must work with their original lender to complete the loan assumption.
- The buyer must go through the standard FHA loan application process. This includes proving creditworthiness to ensure they are qualified to assume the loan.
That’s it. The rest is up to the lender.
VA loans
VA loans are issued by private lenders but guaranteed by the Department of Veteran Affairs. This gives servicemembers, veterans, and eligible spouses more favorable loan terms.
VA loans are a lifetime military benefit. They come with the following:
- No down payment
- Low interest rates
- Limited closing costs
- No private mortgage insurance (PMI)
Fortunately, homebuyers do not need to be service members, veterans, or spouses to assume a VA loan.
The VA does not publish requirements for VA loan assumption. However, many lenders require the following:
- A minimum credit score of 580
- Proof of income
- Ability to pay the funding fee
VA loans assumption comes with a funding fee. The funding fee can equal up to 0.5% of the loan balance. For example, let’s say you want to assume a VA loan with a mortgage balance of $100,000 and a 0.5% funding fee. You’ll have to pay $500 to assume the loan to the lender plus the difference in the home price to the seller.
USDA loans
USDA loans are issued by private lenders and guaranteed by the United States Department of Agriculture. They’re designed for low- to moderate-income rural homebuyers.
Since 97% of the U.S. qualifies as “rural,” USDA loans are a great financing option for anyone who qualifies.
To assume a USDA loan, buyers must meet the following requirements:
- Purchase a property within the USDA’s parameters
- Provide proof of income
- Meet the lender’s credit requirements
- Ensure the seller is current on the existing loan
- Ability to pay the funding fee
- Ability to pay the predetermined down payment
That’s right. Assuming a USDA loan, like a VA loan, comes with a funding fee. The funding fee for the USDA loan assumption is 1% of the loan balance. Additionally, the buyer must be able to pay the predetermined down payment. It’s basically reimbursing the seller for any equity they’ve built up in the home.
Here’s how they work.
Let’s say you want to assume a USDA loan on a home with a mortgage balance of $100,000. The seller has already paid off $10,000 of their loan, and the home price is $125,000, with a funding fee is 1%. You’ll have to pay $26,000 to assume the USDA loan on this home.
Loan assumption after divorce or death
Certain life events may qualify someone to assume a different type of mortgage other than those listed above. These qualifying events are divorce and death. Here’s a closer look at each event and how it may impact loan assumption. Use it as a guide when speaking with a loan advisor.
Loan assumptions after divorce
Let’s say you and your spouse are getting a divorce and have agreed you will keep your shared home. Removing your spouse from the loan makes a lot of sense. Here’s why. It protects your future equity in the property and gives you the right to sell, refinance, or take out a home equity line of credit without involving your ex. It protects your ex-spouse if you default on the loan.
To assume a loan after divorce, you must qualify as the sole remaining borrower, and your ex must sign a release of liability. Each lender has requirements, so be sure to speak with yours about theirs. However, here are some of the things each lender will likely require:
- Provide a copy of your divorce decree
- Prove you can pay the loan on your own
- Apply to be the sole borrower
Please note: Assuming a loan after divorce can only occur after the judge has awarded the family home in the divorce settlement.
Talk to your divorce attorney and mortgage lender to learn more about assuming a loan after divorce.
Loan assumption after death
There are two instances we will explore in this section. The first is the death of a co-borrower or co-signer. The second is inheriting a property.
If your co-borrower or co-signer passes away, you are legally responsible for taking over the mortgage. You do not have to assume the loan because it is already in your name. You will, however, need to notify the lender of your co-borrower’s death. They will advise you on the next steps.
If you inherit a property, you have two options. You may sell the property, or you may assume the loan. Here’s why. Federal law does not require inheritors to keep a property, but it does require mortgage lenders to allow family members to assume the mortgage.
Each situation is unique. We recommend talking with a financial planner, lawyer, or mortgage lender about your problem before deciding the best path forward for you.
Pros and cons of an assumable mortgage
Taking over an existing mortgage might sound like the ideal way to finance a new home, but it does come with some risks. Here’s a look at some of the pros and cons of assuming a mortgage.
Pros of an assumable mortgage
- Easier for sellers to sell a home. Homes with assumable mortgages don’t stay on the market long. Why? They’re a rarity, and real estate investors and homebuyers want them.
- It can save buyers money. How so? Assuming a seller’s mortgage may give buyers access to lower interest rates. They also typically don’t have to pay for an appraisal.
Cons of an assumable mortgage
- Buyers can’t shop around for lenders. That’s right. Because the homebuyer assumes the existing mortgage, they must work with the seller’s lender.
- Sellers risk loss of entitlement. This is true for VA loans. If the homebuyer defaults on the assumed mortgage, the seller risks losing their eligibility for VA home loans in the future.
- Increased financial risk for sellers. It’s true. Here’s how it works. Let’s say a buyer assumes the mortgage of a home and then transfers ownership to another party. The seller can still be responsible for covering mortgage payments missed by the new owner.
Is an assumable mortgage right for you?
As with all financial decisions, it depends on your goals and the risk you’re willing to take. Mortgage assumption can be an excellent option for anyone looking for lower interest rates if the current market has higher interest rates. They can also be more affordable, especially for first-time homebuyers. However, mortgage assumption comes with more risk for buyers and sellers. Talk to your financial advisor to see if an assumable mortgage makes sense for you.
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