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Key takeaways:
- An assumable mortgage/assumable loan allows a Buyer to take over the Seller’s exact loan balance, interest rate, and remaining repayment terms.
- Buyers must pay the gap between the sale price and the remaining loan balance at closing using personal savings or additional financing (this is called the Equity Gap”)
- Government-backed loans like FHA, VA, and USDA mortgages are generally assumable with lender approval, whereas conventional loans usually are not (Buyer to verify!).
What is an Assumable Mortgage Loan?
An assumable mortgage allows a home buyer to take over the seller’s current home loan rather than taking out a new mortgage. The process transfers legal liability for the principal balance to the buyer while keeping intact the existing mortgage rate and loan terms. So, what transfers to the buyer? When assuming a mortgage, the buyer steps directly into the original loan agreement. The components that transfer directly include:
- Interest rate
- Remaining mortgage balance
- Original repayment schedule and term length
Why Lender Approval Matters
Buyers cannot simply begin making mortgage payments on behalf of a seller. You must complete a formal application and underwriting process through the seller’s mortgage servicing company. Formal lender approval ensures the buyer meets credit, income, and debt-to-income ratio (DTI) requirements, while legally releasing the seller from future liability for the loan.
How Does an Assumable Mortgage Loan Work?
Assumable loans work similarly to traditional home loans. The only difference is the buyer must be approved by the seller’s existing lender to assume the loan. By assuming the seller’s mortgage, the buyer agrees to take over the existing terms, principal balance, interest rate, and monthly payments. The buyer also has to pay the lender an assumption fee, usually between 0.05% and 1% of the original loan amount (*this fee could be waived depending on Veteran Disability Status – buyer to verify!). Loan assumptions usually take between 45 and 90 days (but can take longer) to process.
You may also have to make a down payment in the form of compensation equity to close the “equity gap.” Compensation equity refers to the difference between the home’s current market value and the remaining balance on the mortgage. If the price of the home exceeds the remaining loan amount, you’ll have to pay the difference upfront, which may be greater than the down payment you would make on a traditional home loan.
What are the Pros and Cons of an Assumable Mortgage Loan?
Evaluating a mortgage assumption requires weighing potential interest rate savings against higher up-front liquidity demands.
Benefits for buyers
- Lower interest rates: Securing a below-market interest rate reduces monthly principal and interest payments.
- Potential closing savings: Appraisal requirements may be waived by certain loan servicers, saving money up-front.
- Capped fees: Government agency rules possibly could cap total assumption fees that servicers can charge.
Benefits for sellers
- Competitive market edge: Offering an assumable low interest rate makes a listing more attractive to potential buyers.
- Stronger bargaining leverage: Sellers may command a higher sale price or firmer terms due to the value of their underlying loan.
Drawbacks for buyers
- Significant equity gap: Buyers must bring substantial cash to the closing table to close the “equity gap.”
- Inability to rate shop: You cannot shop around with different lenders for alternative rates or terms on the primary loan.
- Third-party facilitator fees: Dedicated assumable mortgage search platforms and facilitators may charge fees that increase upfront costs.
Drawbacks for sellers
- Entitlement risks for Veterans: VA sellers risk leaving their loan entitlement tied up if assumed by a nonveteran buyer.
- Potential liability issues: Failure to execute a formal seller liability release can leave sellers responsible if the buyer defaults.
Who pays the “equity gap”?
- The Equity Gap: The buyer pays the difference between the home’s agreed-upon purchase price and the seller’s remaining loan balance.
- Payment Methods: The buyer can cover this gap using:
- Personal cash savings paid directly at closing.
- A separate second mortgage (such as a home equity loan or a second lien) to borrow the missing equity amount, though the second mortgage will typically carry current, higher market interest rates.*keep in mind this approach will depend on approval of the secondary lien
- Example: If a home sells for $450,000 and the seller’s remaining mortgage balance is $400,000, the buyer must supply $50,000 to cover the difference