By: Michele Lerner for Realtor.com
Looking for an alternative to a traditional mortgage?
An assumable mortgage is a loan that allows a buyer to take over a seller’s current loan, typically with no change to the terms or interest rate.
When interest rates are low or falling, borrowers aren’t interested in taking on a loan with a higher interest rate than what a broker could offer.
But, if you’re purchasing a home with an established loan at 3.75% and mortgage rates have risen to 5.5%, you may want to consider an assumable loan.
Why consider an assumable mortgage
The top benefit to assuming a loan is a lower interest rate than you could get by applying on your own. In addition, your closing costs will be reduced. You’ll still have to pay some fees for the loan qualification process.
If you’re assuming an FHA loan, you won’t need to pay upfront mortgage insurance costs—just the ongoing mortgage insurance payments for the life of the loan.
One other advantage of an assumable loan is that you’ll be paying only the remainder of the seller’s loan.
Some simple math gives you a good example: if a seller borrowed $200,000 for their home purchase in 2011 at 4.2% with a 30-year loan, their monthly principal and interest payments are $978. If you were to borrow $200,000 at 5.2% with a 30-year loan, your monthly principal and interest payments would be $1,098.
In addition, because the seller has already repaid the initial three years of the loan, you would only need to make payments for the remaining 27 years of their loan. The sellers will have paid down $24,562 in interest after three years of payments.
By assuming the loan, you’d save $43,268 over the 30-year loan thanks to the difference in interest rates—plus the interest that the owners have already paid ($24,562)—for a total savings of $67,830.
Assumable mortgage options
Conventional loans are rarely eligible for assumption—most typically require the loan to be paid in full when the property is sold or transferred to another owner. VA and FHA loans are eligible for assumption, but there are a couple of additional requirements:
?FHA and VA loans both require the borrower to be approved for the loan.
?VA loans allow a non-veteran to take over the loan, but the sellers are still responsible for the loan if the new borrower defaults. If a veteran assumes the loan, the sellers are not responsible for the loan after settlement occurs.
Obstacles to an assumable mortgage
Before you run out to capitalize on someone else’s favorable loan, realize that a loan assumption isn’t always on the table.
In addition, you’ll typically need significant cash or to take out a second mortgage if the current home price is more than the remaining mortgage.
For example, if the sellers have made three years of payments as in the example above, their remaining principle due is $189,353. If the home appreciated in value and you buy it for $250,000, you’ll need extra cash as your down payment in order to assume the loan.
Alternatively, you can make a smaller down payment and finance some of the additional cost with a second loan, but be aware that second mortgages are more difficult to qualify for and typically have a higher interest rate than a first mortgage.
A good lender will help you decide whether a loan assumption or a traditional finance makes the most sense for your home purchase.
