Assumable Mortgage

An assumable mortgage is a type of financing arrangement in which an outstanding mortgage and its terms can be transferred from the current owner to a buyer. By assuming the previous owner's remaining debt, the buyer can avoid having to obtain his or her own mortgage.

Many homebuyers typically take out a mortgage from a lending institution to finance the purchase of a home or property. The contractual agreement for repaying the property loan includes the interest rate which the borrower has to pay per month in addition to the principal repayments to the lender. If the homeowner decides to sell his home at some time in the future, he may be able to also transfer his mortgage to the homebuyer. In this case, the original mortgage taken out is an assumable mortgage.

An assumable mortgage allows a homebuyer to assume the home seller’s mortgage – current principal balance, interest rate, repayment period, and any other contractual terms of the mortgage. Rather than going through the rigorous process of obtaining a home loan from the bank, a buyer can take over an existing mortgage which could be a cost-saving advantage depending on the interest rate environment.

In a period of rising interest rates, the cost of borrowing also increases. When this happens, borrowers taking a loan will be given high interest rates on any loans approved. Therefore, an assumable mortgage during this period is an attractive feature to a buyer who will be taking on an existing loan that was made during a time of lower interest rates. While lending institutions will have increased interest rates to reflect the current state of the economy, an assumable mortgage will not be impacted by the changes since the homebuyer will be bound to the terms of the existing mortgage contract which would have a relatively lower locked-in interest rate.

However, the benefits of acquiring an assumable mortgage in a high interest rate environment is limited to the amount of existing mortgage balance on the loan or the home equity. For example, if a buyer is purchasing a home for $250,000, and the seller's assumable mortgage only has a balance of $110,000, the buyer will need to make a down payment of $140,000 to cover the difference, or will have to get a separate mortgage to secure the additional funds. The terms of the existing mortgage only apply to the mortgage balance. Since the home's purchase price exceeds the mortgage balance by a significant amount, the buyer may need to obtain a new mortgage. If this happens, the bank or lending institution may include a higher interest rate on the $140,000 mortgage, depending on the buyer’s credit risk.

Usually, a buyer will take out a second mortgage on the existing mortgage balance if the seller’s home equity is high as seen in the example above. The buyer may have to take out the second loan with a different lender from the seller’s lender, which could constitute a problem if both lenders don’t co-operate with each other or if the borrower defaults on both loans. If the seller’s home equity is low however, the assumable mortgage may be an attractive acquisition to the buyer. If the value of the home is $250,000 and the assumable mortgage balance is $210,000, the buyer need only put up $40,000. If he has this amount in cash, he can pay the seller directly without having to secure another credit line.

The final decision over whether an assumable mortgage can be transferred is not left to the buyer and seller. The lender of the original mortgage has to approve of the mortgage assumption before the deal can be signed off by either party. The homebuyer must apply for the assumable loan and meet the lender’s requirements, such as having sufficient assets and being creditworthy. If approved, the title of the property is transferred to the buyer who makes the required monthly repayments to the bank. If the transfer is not approved by the lender, the seller has to find another buyer that is willing to assume his mortgage and that has good credit.

It is important to note that a mortgage that has been assumed by a third party does not mean that the seller is off the hook on the debt payment. The seller may be held liable for any defaults which, in turn, could affect his credit rating. To avoid this, the seller must release his liability in writing at the time of assumption, and the lender must approve the release request by releasing the seller of all liabilities from the loan.

Conventional mortgages are not assumable. The only two types of loans that are assumable are FHA loans, which are insured by the Federal Housing Administration, and VA loans, which are guaranteed by the US Department of Veterans Affairs.