Assumable Mortgage Loans for the Home Buyer
If the interest rate on the existing mortgage is lower than the rate the buyer could obtain on a new mortgage, either because of prevailing market conditions or the buyer’s poor credit history, the home buyer would benefit from assuming the seller's mortgage loan. However, the biggest hurdle is whether the existing loan secured by a mortgage or a trust deed is fully assumable by a buyer. A fully assumable loan in the real estate field means that a buyer of the property takes over all the terms of the seller's mortgage loan. Most home loans in this country are not assumable. The loan agreement as well as the recorded mortgage or trust deed specifically has an express “due on sales” clause stating that if title of the property is transferred out of that person’s name, the loan then becomes due and payable.
An Assumable Mortgage Loan
If the home buyer takes on all the obligations of the home owner's existing mortgage loan, the purchaser is assuming the seller's loan. Rather than purchasing a new mortgage, the buyer is taking on all the terms of the seller's mortgage, including rate, payment period, and principal balance on the house, as long as the lender approves of the transaction.
Benefits of Assuming a Mortgage Loan
The major benefit for purchasing a home that has a fully assumable loan is a lower interest rate compared to the current market rate. This can make the home very desirable to the buyer. In addition, the purchaser is avoiding the settlement costs associated with a new mortgage. Traditional costs for a loan include escrow fees, document fees, appraisal fees, and points and brokerage commissions for the mortgage broker, with the latter easily in the range of $7,500 to $10,000. Buying real property with a fully assumable loan is a financial savings to a buyer. Rather than applying for a new mortgage, the buyer finds that assuming the seller's existing mortgage is easier and a less costly choice. Furthermore, the lender may go along with some credit blemishes on the buyer's credit rating making it more difficult to get a new mortgage.
Potential Pitfalls of an Assumable Loan
The most obvious pitfall to a buyer is thinking that the loan is fully assumable, but in fact this is not, and the lender can declare the loan due and payable. This results in the buyer scrambling to get a loan. Also, the buyer has no say in the lender chosen by the seller. With a fully assumable mortgage, the buyer is benefiting from the seller's interest rates in a financial market of higher interest rates. The purchaser is saving money as interest rates go up. However, the seller's mortgage might not cover the full cost of the house. A higher down payment or additional financing might still be needed.
Risk to Seller
The seller might still be responsible after the buyer assumes the mortgage loan. Depending on the state and terms of the mortgage, a seller may remain personally liable on the loan until it is paid off in full. If the buyer is late on a payment or fails to make a payment, the seller’s credit rating could suffer. Worse yet, if the assumable loan is not the original loan used in the purchase of the property and the buyer lets the property fall into foreclosure, the seller could very well be responsible for the difference of the amount of the assumed loan and the amount the home was sold in a foreclosure. For example, the initial loan for a property’s purchase was refinanced by the seller for $250,000, the new buyer assumes the refinanced loan, but does not keep up the payments. The lender could foreclose upon the property, sell the property for $210,000, and leave a $40,000 shortfall owed to the lender by the original seller, not the new buyer.
Practically speaking, unless the seller has the finances to cover any missed monthly payments on the assumable loan by the buyer, it is always in the seller’s best interests to have the buyer take out a loan for the property’s purchase. This avoids the seller's liability for the unpaid mortgage, such as the $40,000 in the above example.
In most cases, the buyer will benefit from assuming a seller's mortgage rather than undertaking the expensive process of a new mortgage for the home purchase. Other than making the house purchase more desirable to buyers in general, the buyer's advantages of taking on an assumable mortgage loan are usually greater than the benefits to the seller.