With interest rates higher than they've been in years, potential homebuyers are paying more attention to the idea of assuming the seller's mortgage, which often comes with a much lower interest rate. In fact, "assumable mortgages" have been the number one daily google search term in the US several times in the last month. An assumable mortgage can indeed be a good choice for some homebuyers, but it's not a fit for everyone. Let's dive into the world of assumable mortgages and figure out if it's the right option for you.
Which Types of Home Loans Can Buyers Assume?
Unfortunately, not all home loans allow buyers to assume them. In fact, only about 25% of home loans permit assumption, including FHA, VA, and USDA home loans. This means that for most buyers, assuming a loan won't be possible because the seller doesn't have a loan that allows for assumption. Buyers who come across a seller with an assumable mortgage must meet certain requirements and gain approval from the agency that manages the mortgage.
FHA loans can be assumed when both parties meet the requirements. For example, the property must be the seller's primary residence and must also become the buyer's primary residence.
VA loans can be assumed by anyone, so you don't have to be a veteran or active military member to assume a VA loan. However, many sellers with VA loans might be hesitant to let a buyer who isn't in the military assume their loan because VA benefits (a big advantage for veterans) stay with the property after the assumption, unless the new buyer is a veteran who can transfer their benefits.
How Do Buyers Assume a Seller's Home Loan?
In every situation, the buyer who wants to assume the seller's loan must apply with the seller's lender. The lender needs to check that the buyer meets all the necessary requirements, including having a good credit history. These lenders are usually servicers who may not be very experienced in evaluating and approving borrowers, so be prepared for some obstacles and delays during the approval process. It's a good idea to work out these details with the seller before finalizing the purchase contract. Once approved, the buyer assumes the mortgage.
Usually, sellers will only agree to an assumption if the lender releases them from all responsibility after the assumption. If the seller isn't released, they might still have to make payments if the buyer defaults. Assuming a VA loan requires an extra step of getting approval from the regional VA loan office.
There are services who can assist buyers and sellers in the assumption process in exchange for a fee, typically 1% of the total loan amount, which may be a price worth paying if the seller’s interest rate is low enough.
Does Assuming a Seller's Loan Make Financial Sense?
For those who can assume a seller's loan, the only reason to assume a seller’s loan is if assuming it will save you money. To find out if assuming the seller's loan will save you money, you need to understand the seller’s interest rate and the loan amount.
The biggest challenge when assuming a seller's loan is that it might not provide the buyer with enough financing to purchase the home. For example, if a seller is selling a home they bought 3 years ago for $400,000 with a $300,000 loan at a 3% interest rate, the assumable loan only covers 50% of the purchase price of $600,000, instead of the 95% (or even 97%) financing a buyer could have received by not assuming the loan. That means the buyer has to either (1) come up with $300,000 in cash to cover the rest of the purchase price or (2) get a second loan of up to $100,000 since second loans typically limit total financing proceeds to 80% of purchase price. The second loan might also have an interest rate 1-2% higher than typical purchase loan rates and may not be allowed by the existing lender or available in your area. Plus, the combined average interest rate on the two loans might be higher than what you'd get with a traditional purchase loan at today's interest rates.
On the flip side, if the seller purchased the same home in 2022 with a $300,000 loan at a 4.5% interest rate, it likely makes sense to assume the seller's loan. In this case, the property's value probably hasn't increased much, you may be able to afford the difference in the down payment, and the interest rate is significantly lower than today's rates in September 2023.
When you're considering assuming a loan, it's always a good idea to have a backup plan and get pre-approval from a mortgage broker for more traditional purchase financing. This way, if you find out that a second mortgage isn't possible or if you don't want to invest more money in assuming the seller's loan without a second mortgage, you can still go ahead with the home purchase
To sum it up
Assumable mortgages offer an enticing avenue for homebuyers seeking lower interest rates, but they're not a universal solution. To make an informed choice, consider your unique financial situation and the specific terms of the existing mortgage. Always have a backup plan and explore traditional financing options. Your path to homeownership should be based on what aligns best with your needs and goals, ensuring a successful and financially sound investment in your new home.
If you want to understand your options better, give me a call today at 512-461-7522. I'd be happy to walk your through any questions you have. If you need any help getting pre-approved for a home loan, apply now and one of our loan officers will be in touch as soon as we receive the application.
