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What is an Assumable Loan?
An assumable home loan, also known as an assumable mortgage, is a type of mortgage loan that allows a new buyer to take over or “assume” the existing mortgage of the seller when purchasing their home. In other words, the buyer steps into the shoes of the original borrower and takes over the remaining balance and terms of the loan. This can be an advantageous feature for the buyer, especially in certain market conditions and interest rate environments.
Key Points About an Assumable Mortgage:
- Transferability: With an assumable loan, the buyer can assume responsibility for the remaining mortgage balance instead of obtaining a new mortgage. This can be beneficial when interest rates are higher than the rate of the existing loan.
- Terms and Conditions: The buyer must meet the lender’s qualification criteria to be approved for assuming the loan. They may need to demonstrate their creditworthiness and financial stability, similar to what is required when applying for a new mortgage.
- Interest Rate: The interest rate on the assumable loan will typically remain the same, based on the terms of the original loan. This can be a significant advantage for the buyer if the current interest rates are higher than the rate on the existing mortgage.
- Assumption Fee: Some lenders may charge a fee for allowing the assumption of the mortgage. This fee can vary depending on the lender and the specific loan terms.
- Due-on-Sale Clause: It’s essential to check if the original mortgage contains a due-on-sale clause. This clause gives the lender the right to demand full repayment of the loan when the property is sold. However, some assumable loans may have exceptions to this clause, allowing the loan assumption to take place without triggering the due-on-sale clause.
- Seller’s Liability: In a standard assumption, the original borrower (seller) is generally released from liability once the buyer assumes the loan. This means the buyer becomes solely responsible for the mortgage going forward.
Which Home Loans are Assumable?
Not all loans are assumable. Unfortunately, most conventional mortgages are not consumable. Loans insured by the Federal Housing Administration (FHA) or backed by the Department of Veterans Affairs (VA) or the United States Department of Agriculture (USDA) are assumable as long as specific requirements are met. There are three primary types of loans that could be assumable:
- FHA Loans: FHA loans are government-backed mortgages that are often assumable. The assumption process for an FHA loan typically involves meeting the lender’s qualifying criteria and paying an assumption fee. The buyer assumes responsibility for the outstanding balance and terms of the original FHA loan.
- VA Loans: VA loans, also assumable, are available to eligible veterans and service members. Similar to FHA loans, assuming a VA loan involves qualifying with the lender and paying an assumption fee. The buyer becomes responsible for the remaining balance and conditions of the original VA loan.
- USDA Loans: USDA loans are designed to help low to moderate-income homebuyers in rural areas. Most USDA loans are assumable, but not all USDA loans have this feature. As with FHA and VA loans, the buyer would need to qualify and pay an assumption fee if applicable.
It’s important to note that the assumability of loans can vary depending on the specific terms and conditions set by the lender and the government agency involved. Also, loan guidelines and regulations might change over time, so it’s essential to verify the assumability option with the lender or a qualified mortgage professional at the time of consideration. Read more general information on assumptions at the HUD.gov website.
Assumable Loans Have Future Value
Assumable loans may very well be an asset in the future, when interest rates are almost certain to be higher. Interest rates have reached new lows in the last few years, after a long downward trend, but have risen since mid-2022.
One of the great features of FHA and VA loans is that qualified buyers can assume the loan. (Those originated since 1989) The buyer signs an agreement to pay the debt and becomes the “substitute” borrower. This aspect of a loan hasn’t been of much value in the last few years, since interest rates were falling. But in an environment where interest rates start rising, the assumable loan will be a selling feature to someone who qualifies.
Assumable loans have future value for buyers in a real estate market with rising interest rates. The only issue is that the buyer must have cash to cover the amount between the purchase price and the loan balance. An assumable loan is usually not ideal for a cash-strapped buyer.
What are the Expenses to the Buyer in Assuming the Loan?
The amount of cash a home buyer must have to assume a loan can vary based on several factors, including the specific terms of the assumable loan, the outstanding mortgage balance, and any associated fees. Here are some common expenses that a home buyer might need to consider when assuming a loan:
- Assumption Fee: Some lenders may charge an assumption fee for allowing the loan to be assumed. This fee can vary and is usually a percentage of the outstanding loan balance.
- Down Payment: While assuming a loan does not typically require a down payment, the buyer may still need to pay a portion of the property’s purchase price to the seller in cash. This amount will depend on the negotiated price for the property.
- Closing Costs: Just like in a traditional home purchase, there are closing costs involved in assuming a loan. These costs can include title insurance, attorney fees, appraisal fees, and other charges associated with the transfer of ownership.
- Prepaid Items: The buyer may need to pay for prepaid items, such as property taxes, homeowners insurance, and mortgage insurance premiums if applicable.
- Escrow Account Funding: If the loan being assumed has an escrow account for property taxes and insurance, the buyer may need to fund that account at the time of assumption.
It’s important to note that the amount of cash required to assume a loan will be determined by the specific terms and conditions negotiated between the buyer and the seller. Additionally, the lender’s policies and the loan’s terms will play a role in the overall financial requirements.
Before assuming a loan, potential home buyers should carefully review all the costs involved and consult with a mortgage professional or real estate attorney to fully understand their financial obligations and make an informed decision.
How Quickly Do Interest Rates Rise?
Mortgage experts are always warning about rising interest rates, but we really can’t know. We typically see that as the economy faces inflation, interest rates start to rise, but this last few years has truly been an anomaly. We have never seen interest rates rise so quickly. They doubled in six months.
Please consider that today’s rates at 6 to 7% are still fairly low historically. Since Freddie Mac started surveying lenders, 1971, the average 30-year fixed-rate mortgage interest rate sits at 7.5%.
According to Freddie Mac:
Freddie Mac is forecasting that interest rates will pause at the current rates for the rest of 2023. “We expect inflation to continue cooling as the long and variable lags of monetary policy work through the economy. The slowing growth in prices of goods and services will further reinforce consumers’ purchasing power. We expect mortgage rates to stay at their current status for the second half of 2023.”
It’s important for both buyers and sellers to thoroughly understand the terms and implications of an assumable home loan. If you’re interested in assuming a mortgage or offering an assumable loan, it’s advisable to consult with a real estate attorney or a qualified mortgage professional to navigate the process smoothly and make well-informed decisions. Note that not all mortgages are assumable, so it’s crucial to verify the assumability option before proceeding with any assumption plans.
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Chris & Karen Highland
eXp Realty – 301-301-5119
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