Homebuyers have numerous mortgage options and factors to consider when financing a home purchase – and whether or not a loan is assumable is just one of those many factors.
So, what is an assumable mortgage and how does it work? We explain everything you need to know about assumable mortgages below.
What Is An Assumable Mortgage?
An assumable mortgage is a home loan that can be entirely assumed by a person other than the original borrower. This type of loan is more attractive when interest rates are high because you can assume a loan that was taken out in years past when rates were much lower.
There are two primary types of mortgage assumption: 1) Simple Assumption and 2) Novation.
“Simple Assumption” is a private transaction between a seller and a homebuyer. The buyer takes the title to the home and assumes responsibility for the existing mortgage and the related mortgage payments. This arrangement may not involve loan underwriting.
However, it is important to know that the seller is still liable for the outstanding mortgage debt – when there is no “formal assumption” involving the servicer or current holder of the mortgage. So if the new buyer makes a late payment, the credit profile of the seller will be adversely impacted. The buyer’s credit profile could also be impacted.
“Novation” involves a mortgage lender (the current holder of the mortgage) and the transfer of all rights and responsibilities of the existing loan. With a novation, the lender releases the seller from all liability on the loan and begins to hold the new homebuyer liable for repayment.
For the lender to agree to a novation, the buyer must meet their lender-specific requirements – or effectively qualify for the loan in the traditional manner in most cases.
JVM does not always recommend this route to finance as not all loan types are assumable.
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Are FHA Loans Assumable?
With that being said, FHA loans in particular are usually only assumable if the new buyer qualifies for the loan in the traditional manner.
Assumable FHA Loan Requirements
There are a few requirements to keep in mind when qualifying for an assumable FHA mortgage loan:
- As the seller, you must live in the home as your primary residence for a set amount of time.
- As the buyer, you must go through the standard application process for an FHA loan and meet standard FHA guidelines. This includes being able to put down a minimum of 3.5% with a minimum credit score of at least 580.
- A Maximum Housing Debt Ratio of 46.99% cannot be exceeded. This debt ratio is calculated by dividing the total monthly housing payment by your total monthly gross income.
- A Maximum Debt to Income Ratio (DTI) of 56.99% cannot be exceeded. This debt ratio is calculated by dividing the total of all monthly debt payments (including the housing payment) by your total monthly gross income.
- When assuming a mortgage not subject to the HUD Reform Act of 1989, an investor must pay down the outstanding mortgage balance to a 75% Loan-to-Value Ratio (LTV) if (1) the current owner occupant requests a release of liability or (2) a Direct Endorsement (DE) underwriter signed an appraisal report on or after February 5, 1988. This continues throughout the life of the mortgage.
Additional information such as employment history, income information, and asset verification for a down payment may also be needed to process the loan.
How Does It Work?
In general, an assumable mortgage works the same as conventional loans. However, homebuyers must be approved by and use the seller’s current lender or mortgage holder.
As mentioned previously, the seller puts a lot of trust in the buyer to keep up with the monthly payments. Missed payments may negatively impact both the seller’s and buyer’s credit scores.
How Do You Assume An FHA Assumable Mortgage Loan?
An assumable mortgage applies only to the balance remaining on the original loan. As the buyer, you are responsible for making up the difference by either paying cash out of pocket or taking out a second mortgage, such as a home equity loan.
For example, if the seller has a $200,000 loan balance on a $300,000 home, you must bring $100,000 to the table to compensate the seller for the equity they’ve built.
If you are financing the difference between the assumable mortgage and the home price, you need to find a lender who will qualify you for a second mortgage. The lender may also check your credit score, DTI, employment history, income information, and asset verification to qualify you for an FHA assumable mortgage loan.
Although you must be approved by and use the seller’s chosen lender, you can research options and compare rates to give you peace of mind.
The Bottom Line
An assumable mortgage may be an excellent option if you are looking to take over a previous mortgage loan at a lower interest rate. With that being said, there are a few key factors to keep in mind.
As the buyer, you must be approved by and use the seller’s chosen lender while also meeting all FHA and lender-specific requirements.
As the seller, you risk the buyer missing a mortgage payment and negatively impacting your credit score. This is often why we tend to see assumable mortgages take place between family or with friends, when the seller and buyer already have a personal relationship established.
Interested in learning more about assumable mortgages? Talking with a JVM Mortgage Expert is the first step in buying a home – we will gladly walk you through the home loan process and getting pre-approved.