An assumable mortgage is one that may be taken over by a buyer when a home is sold. Typically, mortgages are assumed because they provide an interest rate advantage to buyers. VA loans and certain FHA loans are assumable, but conventional loans typically are not.
What makes a mortgage assumable?
If a buyer wants to assume a mortgage, the seller cannot simply sign over the loan. The original mortgage document must contain an assumption clause specifically stating that the mortgage may be assumed by another person or entity. If a mortgage loan document contains a due-on-sale clause, the mortgage is not assumable and must be repaid in full when the house is sold. Most conventional mortgage loans contain a due-on-sale clause.
What are the benefits of an assumable mortgage?
Mortgages with an assumption clause can be enticing to homebuyers, especially when interest rates begin to creep upwards. Taking advantage of a lower interest rate is a prime reason for assuming a mortgage, but closing costs are generally lower as well. Assuming a mortgage works best when the current balance of the loan is close to the purchase price of the home. Otherwise, buyers will need to secure financing for the remaining sales price and possibly carry two loans. Before applying for a new mortgage, you may want to calculate the benefits of assuming the existing mortgage if that is an option.
Formal vs. informal assumption
Buyers wishing to formally assume a mortgage must agree to undergo a credit review. The U.S. Department of Housing and Urban Development notes that one exception is for FHA loans originated prior to 1986, which can be taken over by another person under the simple assumption process. For VA loans, a formal mortgage assumption may pose a challenge due to the potential loss of the veteran’s entitlement, according to the Department of Veteran’s Affairs. If the person assuming the mortgage is not also an eligible veteran who is substituting her entitlement, the seller will lose her entitlement and will be unable to apply it to a new home purchase.
If you assume another person’s mortgage payments on an informal basis, the loan will still be attributed to the seller’s credit report. Also, the seller will not be released from her obligation by the lender. To formally assume a mortgage, make sure that you notify the lender and complete all necessary paperwork.
Although interest rates have remained favorable, when rates do begin to rise, assumable mortgages may be an attractive alternative for some homebuyers. If you are purchasing a home and the seller’s mortgage is assumable, calculate the relative costs and benefits of formally taking over their payments.
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