What Is an Assumable Mortgage?

When interest rates are high, assuming a low-interest mortgage is one way to land a manageable monthly payment. Here, we'll take a deeper dive into assumable mortgages, outlining how they work, and how assuming a mortgage may benefit you.

An assumable mortgage is when a buyer takes over the seller's home loan, avoiding the need to take out a new mortgage. An assumable mortgage with a low interest rate can be particularly attractive when market rates are high.

My husband and I have assumed three mortgages. The first time, we chose this method to avoid high interest rates. The Federal Reserve had just raised interest rates and tightened the money supply. The rate on a 30-year mortgage hovered around 15%.

A friend advised us to forego a conventional loan and keep our eyes out for sellers with an assumable mortgage. As discouraged as we were with interest rates, we saved every dollar we could to come up with a $10,000 down payment. Our real estate agent found a young couple ready to divorce and sell their home.

We had two choices: We could take out a conventional loan from a mortgage lender at 15% interest, or assume the seller's VA loan at 6.25%. Either way, we would pay $48,000 for the house and put our $10,000 down. It didn't take long to figure out that the mortgage loan assumption was the only smart move. Principal and interest on a conventional loan at 15% would have cost $480 per month, and we would carry the mortgage for 30 years. By assuming the VA loan, our principal and interest were only $234 per month, and because we took over where the sellers left off, we only had 25 years left on the mortgage.

How does a mortgage assumption work?

A mortgage assumption begins the same way as any home sale -- with a purchase offer. If you assume a mortgage today, you're also required to undergo a credit check and provide documentation like proof of income. Your only other costs will be a minimal funding fee, home inspection, and title insurance to protect your interest.

One major difference from a traditional loan: You don't determine the down payment amount. When a seller allows you to assume their mortgage, the amount you put down equals their equity in the home. The longer they have lived in a house, the more equity they have amassed and the larger the down payment required to assume the loan.

It just so happened that the sellers of our first home were more than happy to accept $10,000 if it meant they could move ahead with their divorce. The VA did not then require a credit check for buyers assuming mortgages, though that has changed. Other than the $10,000, all we paid was a small funding fee. As first-time home buyers, we found it was good to have a real estate agent draw up the offer, negotiate the closing date, and take care of all the details. The sellers paid all real estate fees.

Which mortgage loans are available for assumption?

Mortgage assumption is available on three types of loans: VA, FHA, and USDA. Of these three, VA and FHA are the most commonly assumed.

What are the rules around mortgage assumption?

VA, FHA, and USDA share three basic rules regarding mortgage loan assumption:

• The seller must be current on the mortgage.
• The issuing agency (VA, FHA, or USDA) must pre-approve the assumption.
• The buyer must agree to assume the entire mortgage balance.

In addition, each issuing agency has its own criteria regarding mortgage assumption. Here, we will examine those rules, and outline the benefits and drawbacks associated with each.

VA

VA loans are backed by the Department of Veterans Affairs and are available to military members and their spouses. While only veterans and their spouses can open a VA mortgage, the VA allows non-veterans to assume the loan, as long as they are deemed creditworthy.

Benefits

• Assuming a VA loan makes it possible to obtain a lower interest rate than is currently available.
• The buyer pays thousands less in fees, including appraisal and closing costs.
• When a veteran first uses VA entitlement to purchase a home, there's a funding fee of up to 2.3% (it varies with down payment amount). The second time, the fee can be up to 3.6%. However, when a buyer assumes a VA loan, they are charged only a 0.5% funding fee. On a $250,000 loan balance, this would equal an assumption fee of $1,250.
• Selling a home through mortgage loan assumption can be a huge advantage in a slumping market, or when mortgage rates are through the roof. An assumable VA loan can help a property stand out in the crowd and become a magnet for house hunters.

Drawbacks

• There is no rule saying that a lender must allow a VA loan to be assumed. Some will and some will not.
• Not all VA assumptions can be approved "in-house." Some lenders are required to send assumption requests to a specified VA loan office, and then wait to hear back.
• It can be tough to find a seller open to assumption. That's because the seller's credit can take a hit if the party who assumes the mortgage makes late payments or defaults on the loan. The only way to avoid this is for the seller to obtain a mortgage liability release from the lender.
• Sellers may also be hesitant to give up their VA entitlement. Normally, a VA purchaser is free to use the VA entitlement again once a property has sold. In the case of an assumption, the entitlement is out of play until the original mortgage is paid in full. The only workaround is if the person assuming the loan is also a veteran and has an unused entitlement they are willing to use so that the seller can reclaim theirs.

FHA

FHA mortgages are government-insured loans administered by the Federal Housing Administration. An FHA mortgage loan assumption is only available on single-family homes.

Benefits

• FHA has some of the most forgiving lending practices in the business, and it may be easier to qualify for an FHA mortgage assumption than other loan types.
• Mortgage loan assumption means taking over where the seller left off. If the seller has been in the house for 10 years, that means cutting 10 years off the time it takes to pay off the loan.
• As with a VA loan, selling a home with an assumable FHA mortgage can be an advantage when the market is sluggish, or when the interest rates are on an upward trajectory.
• The most a buyer can currently be charged to assume an FHA mortgage is $900.

Drawbacks

• The required down payment may be significantly higher when assuming an FHA mortgage than it would be if the buyer was taking out a new mortgage -- particularly if the sellers have been in the home long enough to build up equity.
• The buyer may be required to pay mortgage insurance, at least for a while. Depending on when the home was originally purchased and how much the seller put down, mortgage insurance can run anywhere from 0.45% to 1.05% annually (making the insurance premium on a $250,000 home $94 to $219 per month).

USDA

USDA loans are also government-insured, and are administered by the U.S. Department of Agriculture. USDA mortgages are designed to help people buy homes in rural communities and outlying metropolitan areas. One draw for original buyers is that USDA mortgages provide 100% financing, a sweet deal for those without funds to make a down payment. USDA mortgages are available only to buyers with low to moderate incomes.

Benefit

• Although buyers can expect to pay some fees, including a credit check, title report, and assumption fees, the cost of assuming a USDA loan is one-fourth to one-third the cost of closing on a new USDA mortgage. One fee a buyer assuming the loan avoids is the 1% funding fee paid by the original buyers. On a $150,000 mortgage, being able to bypass that fee alone saves $1,500.

Drawbacks

• Only properties in USDA-designated areas qualify.
• Buyer must earn a low to moderate income to qualify.

What are the qualifications for assuming a mortgage?

To qualify for a VA, FHA, or USDA mortgage assumption, a buyer must be deemed "creditworthy." This means that their credit score must meet a minimum standard, they must have a history of repaying debts as promised, and their debt-to-income (DTI) ratio must be below the limit set by the lender. Beyond that, each loan type requires a minimum FICO® Score:

• VA mortgage: There is no minimum credit score set by the Veterans Administration, but individual lenders typically require a score of 620.
• FHA mortgage: To assume an FHA mortgage, buyers must have a FICO® Score of 580 or higher.
• USDA mortgage: A buyer needs a FICO® Score of 640 or higher to assume a USDA mortgage loan.

How to assume a mortgage

Mortgage assumption is like any home purchase: you should approach it by being prepared. Check your credit score to make sure it's up to snuff. Calculate your debt-to-income ratio to ensure you are bringing in more than enough money to cover your obligations. And finally, make sure to have an emergency fund put away for unexpected expenses. As exciting as buying a new home is, you will enjoy it even more if there is no reason to worry about finances.

When it's time to buy, let a real estate agent know that you are looking for an assumption. Also tell them how much you have for a down payment so they can zero in on properties that fit your budget. Although you could seek out an assumption on your own, real estate agents are the people most likely to know where they can be found, and which sellers are open to the idea. They also have the most experience putting together mortgage assumption offers and writing contracts that protect your interests (like including a clause that allows you to back out of the deal without penalty if a home inspection turns up any major defects).

Once you find the home of your dreams, you will sign a purchase offer and include earnest money (sometimes referred to as a "good faith deposit"). The amount varies, but expect 1% to 3% of the purchase price. Earnest money shows the seller that you are serious, and counts toward the down payment when you close on the house.

After the seller agrees to your offer, it's time to order a home inspection. As tempting as it may be to take the seller's word for the condition of the home, an inspection gives you an unbiased picture of the property's condition. Nationally, the average cost of a home inspection is $328. It's a small investment for peace of mind.

Once the original lender has pulled your credit report, asked about any issues that require clarification, and ensured that you meet their minimum requirements as a borrower, the deal should quickly move toward closing. Your real estate agent will let you know where closing will take place and which documents to bring with you. It is at closing that you will pay any fees associated with the loan assumption.

You may not be able to control the market or interest rates, but knowing how to assume a mortgage allows you to decide which method of financing will best serve your needs. To make the mortgage assumption even sweeter, the best mortgage lenders have streamlined the process to make it easier for everyone involved. Whether you decide to assume an existing mortgage or not, you can't go wrong having the option in your back pocket.

Still have questions?

Here are some other questions we've answered:

• What Is Home Equity?
• What Is a Conventional Loan?
• Pending vs. Contingent Home Sales: What's the Difference?