Taking Over the Seller’s Mortgage With a Loan Assumption

In a typical real estate sale, the buyer puts some money down then gets a mortgage to finance the rest of the purchase. At closing, the seller typically uses the buyer’s loan proceeds to pay off any existing mortgages or other liens on the property. But this isn’t always what happens in a property transfer. In some cases, a buyer may take over the seller’s responsibility for the mortgage instead of taking out a new loan. This is called an assumption of the loan. 

Assumptions are not available for all mortgages, and they’re not the right choice for every situation. In certain circumstances, though, assumptions can be helpful to the buyer, the seller, or both. Read on to learn more.

What Is a Mortgage Assumption?

A mortgage assumption is the process of a buyer taking over, or assuming, the seller’s existing home mortgage. The principal balance, interest rate, repayment period, and other terms of the loan typically don’t change in an assumption. The assumption applies only to the balance remaining on the original loan, which may not completely cover the property’s price. The buyer must make up any difference, either by paying cash or by getting a second mortgage like a home equity loan. 

Assuming a mortgage to buy a property sounds simpler than it is. The buyer still has to provide extensive documentation to the lender, and the approval process can take up to 90 days. The assumption process is typically more straightforward in the case of divorce and inheritance. After a divorce, a lender will request verification that the spouse who is staying in the family home meets certain eligibility requirements. After that, the mortgage holder will release the other spouse from liability on the loan. Similarly, someone who inherits a house can choose to assume the mortgage if they meet eligibility requirements.

The 2 Types of Mortgage Assumptions Explained

An assumption of a home loan can be either a simple assumption or a novation.

A simple assumption is a private transaction between a home seller and a buyer, where the buyer takes the title to the home and assumes responsibility for the seller’s mortgage payments. The transaction may not involve loan underwriting. The seller remains liable for the outstanding mortgage debt, so if the buyer misses payments or defaults on the loan, the credit scores of both the buyer and the seller would reflect this.

In a novation, a mortgage lender transfers the rights and responsibilities of the existing mortgage from the seller to the buyer. The lender releases the seller from all liability on the loan and then holds the buyer solely liable for repayment. For the mortgage holder to agree to a novation, the buyer must formally qualify for the loan. Unless you’re assuming a relative’s mortgage, to assume a mortgage loan, you’ll need to meet the same credit and income requirements that apply for a new loan.

Can Any Mortgage Loan Be Assumed?

Conventional mortgages generally can’t be assumed, but loans backed by the federal government are usually assumable.

Conventional Mortgages & Loan Assumptions

It’s rare to find a conventional mortgage loan that allows assumption because assumptions are not profitable for conventional lenders. If lenders allowed loan assumptions, they’d lose out on the money from closing costs, loan origination fees, and the interest of new mortgage loans.

Conventional loans usually prevent assumptions by including a due-on-sale clause in the mortgage contract. This clause allows the lender to “call” the loan. That means they can declare the outstanding loan balance due and payable if the loan is sold or transferred without the lender’s prior approval. A mortgage holder can’t legally exercise a due-on-sale clause in a divorce or when a parent passes away and leaves the home to offspring in a will.

If you read your conventional mortgage agreement and don’t find a due-on-sale clause, you should still call your lender before you assume you can transfer the mortgage. If you transfer property without properly confirming that the mortgage is assumable and it turns out to be non-assumable, your credit score will be hurt severely if the new owner defaults. Defaulting on a mortgage can make it difficult to get another mortgage in the future.

Government-Backed Loans & Mortgage Assumptions

Government-backed loans (FHA, VA, USDA) generally qualify for assumption. 

FHA Loans

An FHA loan is a mortgage that is insured by the Federal Housing Administration (FHA). These loans are popular with first-time homebuyers who have credit issues or limited funds for a down payment. FHA loans are assumable.

FHA loans that originated on or after December 15, 1989, require an FHA lender to review the creditworthiness of the borrower who wants to assume the loan. There are exceptions to this credit approval rule, though. Credit approval is not required if the property was gifted to an heir upon the original borrower’s death or when an original homeowner transfers property but keeps their ownership interest in it. There’s an assumption fee for these loans of up to $900, plus credit report and processing fees.

The seller will remain liable on an assumed loan unless they’re released from the loan. The lender must sign an official home purchase approval and liability release document to do this.

VA Loans

A VA loan is a mortgage that is guaranteed by the U.S. Department of Veterans Affairs (VA). Only active-duty servicemembers, veterans, and eligible surviving spouses are eligible to apply for these loans. VA loans are assumable. Borrowers who assume a VA mortgage are not required to be an eligible military borrower or surviving spouse.

VA loans that originated after March 1, 1988, require buyers to meet certain credit and income qualifications to assume the mortgage. Loans originated before that date are freely assumable, meaning the buyer can assume the mortgage without prior approval from the VA or a VA-approved lender. But if the seller wants to be released from liability on the loan, the buyer must qualify to assume the loan. The VA allows unrestricted assumptions in a divorce or upon the death of the homeowner. There’s typically a VA funding fee (0.5% of the loan), a processing fee (usually $300 or more), and a credit report fee to assume a VA mortgage.

Assumable VA loans have one major drawback for the seller involving their VA entitlement. The seller can’t get another VA loan until the buyer pays off the assumed loan unless the buyer is also an eligible military borrower or qualified spouse. In that case, the buyer may be able to substitute their own VA loan entitlement for the seller’s.

USDA Loans

A USDA loan is a loan guaranteed by the U.S. Department of Agriculture (USDA). These loans allow low or moderate-income borrowers to refinance or purchase homes in rural areas with no down payment. The location of the property must meet the USDA’s definition of “rural” to qualify for these loans. 

The USDA allows two types of loan assumption: new rates and terms or same rates and terms. Most USDA loan assumptions are with new rates and terms, which means the assumed loan balance is re-amortized with a new interest rate and loan terms. In limited situations like divorce or death, the USDA allows an assumption with the same rates and terms, where the buyer assumes the seller’s outstanding loan balance with the same interest rate and the existing amortization schedule.

What Are the Advantages and Disadvantages of Assumable Mortgages?

There are several advantages for buyers who assume a mortgage. Depending on current interest rates and when the loan originated, you may be able to get a lower-than-average mortgage interest rate on an assumption. This can be helpful if you’re being priced out of the housing market because of higher interest rates on home loans. The mortgage amount on an assumption is likely to be smaller than if you took out a new loan, and you might pay less in closing costs since standard underwriting isn’t involved. Closing costs involving a new loan are typically 3% to 6% of the mortgage, largely due to loan origination and other lender fees.

Assumptions have disadvantages too. If the seller has significant equity in the property, you may have to pay a significantly higher down payment than if you got a new mortgage. This is because you’d have to cover the seller’s equity. You’ll want to make sure the lender of the assumable mortgage knows that you’re getting a second mortgage because it could be prohibited by the first mortgage’s contract terms. You’ll also want to make sure the combined loans don’t exceed the first mortgage lender’s required loan-to-value (LTV) ratio.

Another drawback to assumptions is that you’ll have to meet the lender’s credit and income requirements if the seller wants a complete release of liability on the loan (which is likely). And even though you’d avoid loan origination costs with an assumption, you could be charged a loan assumption fee, various processing fees, and credit report fees on top of closing costs.

Whether or not an assumable mortgage is an advantage to a seller depends on current interest rates. A seller having trouble attracting buyers may find that having an assumable mortgage is a helpful marketing feature if interest rates for new loans are high and the interest on the assumable mortgage is low. This is because a single point difference in interest could save thousands of dollars in interest over the life of a loan. But if rates are low, assumable mortgages tend to lose their appeal, especially if the buyer has to come up with a significantly higher-than-normal down payment to cover the seller’s equity.

Let’s Summarize...

Mortgage assumptions allow a homebuyer to take over a seller’s existing home loan. An assumption can be a novation, which requires the buyer to qualify for the loan, or a simple assumption, which does not. Conventional mortgage contracts typically have a due-on-sale clause that makes the loan unassumable, but government-backed mortgage loans through FHA, VA, and USDA can generally be assumed. 

Buyers may secure a lower interest rate and a smaller mortgage amount with an assumed mortgage, but they might have to come up with a larger-than-normal down payment to cover the seller’s equity. An assumable mortgage can be helpful to a seller when interest rates are high, but assumable loans tend to lose their appeal when rates are low.