Assumable mortgages

In short

A friend of mine bought a house last spring and took over the seller's old loan, rate and all. If you are holding a mortgage with a low rate, or hoping to find one, the idea is worth understanding. An assumable mortgage lets a buyer step into the seller's existing loan instead of getting a new one. The buyer keeps the old interest rate and the old payoff date. The lender must still approve the buyer, and the plan requires a written release before the seller is free of the debt. The buyer also has to cover the gap between the home price and the loan balance. That gap can be large. Ask the servicer, who collects the payments, whether the loan can be assumed before you do anything else.

The whole of it

What it is

I once watched an old farmer hand his neighbor a worn set of keys and say the fence came with the land. An assumable mortgage works a little like that. The loan comes with the house.

Here is the plain version. When someone buys a home with a mortgage, the loan normally gets paid off at closing. The seller's lender is repaid, and the buyer gets a brand new loan at today's rates. With an assumption, the old loan stays alive. The buyer takes over the remaining balance, the interest rate, and the number of years left. The seller walks away from the payments, if the lender agrees.

Not every loan can be assumed. Most conventional loans carry a due on sale clause, which says the whole balance comes due when the home is sold. That clause shuts the door. Loans backed by the Federal Housing Administration, the Department of Veterans Affairs, and the U.S. Department of Agriculture are different, because their own rules allow assumption when the buyer qualifies. That is why you hear about this mostly with FHA, VA, and USDA loans.

How it works

You have probably heard that a low rate is a treasure. It is. But the treasure comes with a toll, and I would be a poor friend if I hid the toll.

The buyer starts by asking the seller's servicer for an assumption package. The servicer is the company that sends the monthly bill. The buyer then applies, and the lender looks at credit, income, and debts, much like with any loan. This takes time. Assumptions often move slower than a regular purchase, so patience matters.

Now the part that surprises people. The buyer takes over the loan balance, not the home price. If the home sells for $300,000 and the loan balance is $180,000, the buyer still owes the seller the $120,000 difference. Someone has to pay that gap. The buyer can pay cash, or take out a second loan, but a second loan comes at current rates and can eat up the savings.

Then there is the question of release. The seller wants to be let off the hook. For FHA loans, the lender must process a release of liability for the seller to be fully free. For VA loans, the seller must also request a release, or the seller's entitlement can stay tied up in the old loan. Entitlement is the amount the VA promises to back. If no release is signed, the seller could still be on the hook if the buyer stops paying.

Fees apply too. The lender may charge a processing fee, and the buyer pays closing costs. The official FHA and VA pages describe the rules, and the servicer sets the actual fee within them.

The numbers, and where to find yours

Folks like numbers they can check, so here is where to look. The first number is the interest rate on the loan. It is printed on the monthly statement and on the original note. The second is the unpaid balance, also on the statement. The third is the number of years left, which you can find on the amortization schedule or by asking the servicer.

For limits set by law, I will not guess. The FHA fee and rules for assumptions are set by the Department of Housing and Urban Development, and the VA funding fee for an assumption is a percent set by law, currently the current figure, which the official source publishes each year. A loan can only be assumed up to the program's own loan size cap, which for FHA in your county is [rule:fhа_loan_limit_for_one_unit_home]. Check those figures against the official HUD and VA pages, because they change.

To find your own loan type, look at the first page of your closing papers. It will say FHA, VA, USDA, or conventional. Short answer. Look there first.

A worked example

Let me tell you about a woman named Dolores. She found a house listed at $300,000. The seller had an FHA loan with a balance of $180,000 and a rate of 3 percent, with 25 years left.

Dolores asked the servicer about assumption. It was allowed. She applied, and the lender approved her income and credit. She now had to cover the gap. The price of $300,000 minus the balance of $180,000 is $120,000. She had $50,000 in savings and borrowed $70,000 on a second loan at 8 percent.

Look at her monthly payments. The assumed loan carries a balance of $180,000 at 3 percent over 25 years. That payment is about $854 a month for principal and interest, which is the loan itself plus the interest charged on it. The second loan of $70,000 at 8 percent over 15 years is about $669 a month. Together that is $854 plus $669, or $1,523 a month.

Now compare a brand new loan. Say Dolores borrowed $250,000 at 7 percent for 30 years, with the same $50,000 down. That payment is about $1,663 a month. So $1,663 minus $1,523 is $140 a month saved. Over a year that is $140 times 12, or $1,680.

That is a real saving. It is also much smaller than people expect, because the second loan carried a high rate. Had Dolores held $120,000 in cash, the saving would be larger. Her situation shows the whole point. The low rate helps, but the gap decides the outcome.

Where it goes wrong

I have seen good people get tripped up here, and not because they were careless. The rules are just tangled.

The biggest trap is the gap. A buyer who cannot cover it may find the deal falls apart, or ends up with a costly second loan. Do the math before falling in love with the rate.

Another trap is the seller's release. If the lender does not release the seller, the seller may stay liable. A seller who skips this step could be pulled back into a debt on a house that is no longer theirs. For a VA loan, the seller's entitlement may stay locked up too.

A third trap is the due on sale clause. If a conventional loan has one and the home changes hands without lender approval, the lender can demand the full balance. That is a hard lesson. Never sidestep the lender.

Time is a fourth trap. Servicers can be slow, and a purchase contract has deadlines. A buyer should ask for extra time in writing, and the contract should say what happens if the assumption is denied.

Last, remember that mortgage insurance may carry over. FHA loans charge a mortgage insurance premium, and it can stay with the loan. The buyer should ask how long it lasts. Costs hide in small print.

Questions to answer before you leave this page

Have you looked at your closing papers to learn whether the loan is FHA, VA, USDA, or conventional? Have you asked the servicer, in writing, whether the loan can be assumed and what the steps are? Do you know the loan balance and the home price, and can you say out loud how big the gap is? Where would the money for that gap come from, and what would it cost each month? Have you added up the fees, the closing costs, and any mortgage insurance that stays with the loan? If you are the seller, will the lender sign a release so you are free of the debt? And if the assumption is denied, does your contract let you walk away without losing your deposit?