Mortgage BasicsHow Does Mortgage Assumption Work?

How Does Mortgage Assumption Work?

In most cases, when it comes to buying a house, a homebuyer needs to apply for a new mortgage with terms depending on their credit score, down payment, and the current mortgage rates. However, did you know that you could buy a house while taking over the previous owners’ mortgage?

This type of transaction is known as mortgage assumption and can come with many benefits for homebuyers. They become particularly attractive when the interest rates are rising, which is currently the case with the Fed announcing rate hikes in the coming months. Therefore, after years of being largely ignored with mortgage interest rates remaining near historic lows, mortgage assumptions are becoming, once again, an attractive option for homebuyers.

This guide answers some of the most frequently asked questions about mortgage assumption, so you can decide if it is a good fit for you.

What Is An Assumable Mortgage?

An assumable mortgage allows the buyer to take over the previous property owner’s existing home loan. This includes the terms attached to the mortgage, such as the outstanding balance, interest rate, and repayment period. It’s an interesting arrangement if the loan terms are more favorable than the homebuyers would otherwise obtain on their own – if the interest rates have significantly increased. It is also common if the property is transferred to a family member following death or one of the partners during a divorce.

An assumable mortgage comes with different conditions. First of all, a mortgage assumption cannot occur unless the seller is up to date with their mortgage payments. Besides, in most cases, the lender and the agency sponsoring the mortgage (if applicable) must approve the would-be homebuyer. They must be able to go through the typical underwriting process, including proving their income and having a high enough credit score and a reasonable debt ratio to qualify for a loan. The requirements depend based on the lenders and the type of loan. However, with an assumable mortgage, the homebuyer will not be able to shop around for a different lender for better terms.

What Mortgages Are Assumable?

Not all mortgages are transferable. Conventional mortgages are typically not assumable, but the lender may consider exceptions for adjustable-rate mortgages. The most popular assumable mortgages are primarily government-backed mortgages, including the FHA, VA, and USDA loans. For VA loans, the homebuyer does not need to be an active or retired member of the military to assume of VA loan, but it may make the transfer easier for the seller.

Finally, the homebuyer also needs to repay the seller’s home equity, and they may need to contract a second mortgage if the amount required is too high. This usually happens if the property value has increased drastically or if the seller has owned the property for a long time.

What are the Pros and Cons of Assumable Mortgages?

Mortgage assumptions come with several advantages and disadvantages, both for the buyer and the seller.

Pro: Lower Monthly Payments

On the buyer’s end, an assumable loan can provide lower interest rates than those currently available in a rising interest rate environment. For a $400,000, 30-year fixed-rate loan, a one percent difference in interest rate could save the buyer upwards of $2,000 a year.

Pro: Lower Closing Costs

In addition, the closing costs are also often lower for mortgage assumptions than when contracting a brand new mortgage since the FHA, VA, and USDA impose limits on assumption-related fees, saving buyers hundreds of dollars.

Pro: Great Incentive to Attract Buyers

On the seller’s side, offering an assumable mortgage can be an attractive marketing argument if the interest rates have significantly increased since they initiated their mortgage.

Con: Potentially Higher Down Payment

However, the buyers may also need to pay a significantly higher down payment than most mortgages – especially government-backed loans – since they will need to pay off the previous owner’s home equity. In some cases, the buyers may need to take out a second loan, which often comes with higher interest rates, increasing their debt-to-income ratio and adding extra closing costs. It is best to focus on homes that sold relatively recently (a couple of years) to the previous owners if you are considering taking over someone else’s mortgage. 

Con: Private Mortgage Insurance

If the seller sells the property before they have 20% equity built up in their home, the buyer assuming the mortgage will likely need to pay for private mortgage insurance. Of course, the buyer will be able to request the removal of PMI once the equity reaches 20%.

For VA Assumable Loans

There are few inconveniences if the mortgage being assumed is a VA loan. Part of the borrowers’ entitlement (the dollar amount that the government guarantees if the borrower defaults) remains tied up in the assumed loan. This means that the seller will not be able to take out a new VA loan unless the new buyer is a veteran or member of the military and is eligible to get a VA loan. In that case, the homebuyer’s settlement can be substituted for the seller’s, who gets access to their full entitlement.

How to Assume a Mortgage?

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

Simple Mortgage Assumption

A simple mortgage assumption is a private transaction between the buyer and the seller. No lender would be involved in the simple mortgage assumption process. The buyer takes over the seller’s mortgage payments in exchange for the title to the home without going through the underwriting process. Although this type of mortgage assumption allows the buyer to bypass expensive closing fees, the original borrower retains full liability for the mortgage. They will be held responsible if the new homeowner defaults on the loan. Since this type of arrangement is particularly risky for the sellers, it is very rare except for family transactions (such as a child taking on their parents’ mortgage.)

Novations represent the vast majority of mortgage assumptions. They require the lender’s approval, with the buyer going through the underwriting process, including credit evaluation, financial and employment review, and so on. If the buyer meets the lending requirements, the lender releases the seller from their liability on the loan. While it represents more hoops to jump through than a simple mortgage assumption for the buyer, it is less risky for the seller. It’s also slightly more manageable than applying for a new mortgage, as it’s unlikely that the lender will require an appraisal.

Alix Barnaud

After graduating with a Master’s degree in marketing from Sciences Po Paris and a career as a real estate appraiser, Alix Barnaud renewed her lifelong passion for writing. She is a content writer and copywriter specializing in real estate and finds endless fascination in the connection between real estate, economic trends, and social changes. In her free time, she enjoys hiking, yoga, and traveling.