Spoiler alert, assume they will not make a comeback—what options are out there for your clients?
Purchasing a new home can be done through various ways for potential home buyers. Most buyers take out a conventional mortgage, though some opt for all-cash purchases. With interest rates much higher than they were just a few months ago, there’s one type of mortgage that seems to be coming out of the shadows, the assumable mortgage. Assumable mortgages had their heyday in the 1980s when mortgage interest rates were in double-digit territory for years. Since that time, most lenders have structured their loan terms to prohibit the practice, however there are some exceptions. Many federal loan programs still allow assumable mortgages if specific criteria are met. Even though this type of mortgage may seem like an unlikely option, it is still important to understand what they are. Many buyers and sellers out there could have questions about it, so it is good to be in the know. An assumable loan is exactly what it sounds like. Instead of getting a new loan, a buyer will have the chance to assume/take over the seller’s mortgage loan. This is beneficial for the buyer because they will have the opportunity to take advantage of financing the home with a lower interest rate.
Assumable mortgages allow buyers to skip the process of finding a lender. The new buyer will be liable for the current principal balance, repayment period, interest rate, and other terms in the contract between the seller and lender. For example, suppose a homeowner was selling their property for a current market value of $450,000 and had a remaining mortgage of $200,000, the buyer will be responsible to cover the remaining $250,000, most likely as a cash down payment.
Types of Assumable Loans
Now we must realize not all home loans are considered equal. Usually, mortgage loans that are backed by the government like Federal Housing Authority (FHA), U.S. Department of Agriculture (USDA), and Veterans Affairs (VA) are assumable. Typically, conventional loans are not assumable. The reason why conventional loans are not assumable is because most of them have a “due on sale” clause in the loan contract but may vary with some private lenders. Some situations like a transfer of real estate through death, divorce, or trust inheritance will not trigger the due-on-sale clause.
For an FHA loan to be assumable, the contract must have been in effect after December 1, 1986, and the lender is required to verify if the buyer’s credit allows them to qualify. The buyer must also meet the underwriting guideline for an FHA loan which is to have a minimum credit score of 580 (could differ for individual lenders) and have a debt-to-income ratio that doesn’t exceed 31% for housing expenses and 41% for total monthly expenses.
The USDA must pre-approve whether a USDA mortgage is assumable, and it won’t be approved if the seller is behind or default on their payments. For a buyer to qualify, USDA requires them to have a minimum credit score of 640, the buyer’s household income cannot exceed 115% of the median income for the area, and debt-to-income ratios should not exceed 41% for monthly expenses and 29% for housing expenses.
Since VA loans serve the military (it is backed by the Department of Veteran Affairs) it is easier to assume a mortgage compared to FHA and USDA loans. The process for assuming a VA loan is quite different from the other government loan programs. There is no minimum credit requirement, but usually a lender will assess if the buyer is fit to assume a VA loan if they have at least a credit score of 580. Down payments are also not usually required but it does vary by lender. Lastly, the buyer’s income must be able to sustain the loan amount and there will be a funding fee of 0.5% of the loan.
Pros and Cons of Assumable Mortgages
|Ø Buyer saves money if the assumable interest is low.||Ø Risk of default on payment when a buyer assumes a mortgage and transfers ownership to an undisclosed third party (e.g. renting) without notifying the seller.|
|Ø Fewer closing costs.||Ø The seller can lose their VA entitlement which can affect if they will be eligible for another VA loan.|
|Ø Great marketing tactic to attract buyers.||Ø Buyers are limited to the original terms and conditions.|
|Ø No need for appraisal.||Ø Larger down payment.|
|Ø A second mortgage can be problematic because there are two lenders involved.|
If you have a client looking to assume a mortgage here is the procedure to follow.
- Look in to see if the loan is assumable.
- Send the current lender an assumption request.
- Submit personal financial information for review.
- Modify the deed and all parties must sign the assumption agreement.
Because conventional loans do not allow someone to assume an existing mortgage, it is very unlikely that assumable mortgages will become a widespread option today. Despite this limitation, it is important to understand what options are out there, and how your clients could explore these options if the conditions are right. As always, be sure to ask a mortgage consultant to find out more detailed information about these loan options.