What is an assumable mortgage?

If you stand to inherit property in the future or are looking for a potential deal on your next home, you may consider assuming a mortgage to finance the purchase of a home. An assumable mortgage is a mortgage loan that another borrower can take over while keeping the original terms and conditions, which is sometimes better than taking out a new mortgage.

While not every home’s mortgage loan can be transferred to a new borrower, some can and could offer up substantial savings. To assume a mortgage, you must first get lender approval. Loans backed by the FHA, VA and USDA are assumable as long as you satisfy specific requirements (much like with getting a new loan).

What is mortgage loan assumption?

A mortgage loan assumption lets you take over someone else’s existing mortgage loan, usually in a home sale transaction. Essentially, the buyer agrees to assume the seller’s current mortgage instead of taking out a new mortgage of their own to pay for the home.

When you assume another borrower’s mortgage loan, you accept all other terms of the loan agreement — the interest rate, repayment period, fees and other terms typically don’t change with a new borrower. You’re also required to pay the difference between the loan amount and the home’s purchase price. The agreement releases the seller from further liability.

Here’s how it works: You purchase a home for $250,000, and the seller has a remaining loan balance of $200,000. If you assume the mortgage loan, you take over the $200,000 balance and give $50,000 to the seller at closing (the difference between the sales price and the loan balance).

Which mortgages are assumable?

Not all mortgages are assumable. Most conventional fixed-rate mortgages are not assumable because of the due-on-sale clause written into the mortgage agreement.

Lenders cannot enforce a due-on-sale clause in specific circumstances, including when you inherit property or if you take over a mortgage during a divorce.

A due-on-sale clause lets the lender require the borrower to pay the outstanding loan balance on the sale or transfer of a mortgage without the lender’s prior consent. There are a few circumstances where lenders cannot legally act on the due-on-sale clause, like in cases of divorce or family members inheriting property as part of a will.

Many government-backed mortgages (including USDA, FHA and VA loans) are assumable if you meet certain requirements.

To assume a USDA loan, the property must be in a USDA-approved location and the seller must be current on payments. Also, the buyer must still meet income, debt-to-income ratio and credit requirements set by the lender.

FHA loans are also assumable, but they may have different requirements depending on when the loan started. Mortgages that originated before Dec. 1, 1986, don’t have as many restrictions as those that originated after this date. Newer mortgages may require a thorough review of the borrower’s credit to determine eligibility.

In addition, VA loans are assumable, even if you aren’t a military service member or a veteran. You'll still have to meet other lender guidelines for creditworthiness. ConsumerAffairs’ mortgage loan officer Jennifer Ashley notes that, for VA loans committed and closed on or after March 1, 1998, assumptions aren’t allowed unless the veteran first has the assumption approved by the VA.

How to assume a mortgage

To assume a mortgage, you’ll take many of the same steps you would if you applied for a new mortgage, including completing an application and letting the lender check your credit report. The lender may also require documentation for proof of income (like W-2s and prior tax returns).

Assumable mortgages and divorce

In the event of divorce, one spouse may choose to assume the mortgage and keep living in the current property. This shifts the responsibility of the mortgage onto one person.

The lender will need to verify the new borrower’s eligibility requirements to ensure they can afford the mortgage payment on their own. If the resident spouse is eligible for the mortgage, the lender will remove the financial responsibility of the home from the nonresident spouse.

Assumable mortgage benefits and drawbacks

One major benefit of assumable mortgages is that you can inherit another borrower’s interest rate. If rates were low when the mortgage was originated, you could save a lot of money in interest by locking in the original rate versus the current market rate.

For example, say you assume a 30-year fixed-rate mortgage originated in 2013. The interest rate on the mortgage may be 3.98%, while the average rate today is 4.72%, according to the Federal Reserve Bank of St. Louis. One percentage point difference in interest, especially on a mortgage, can result in significant savings in monthly payments and in overall interest paid because of the long repayment period.

Another advantage is that you could pay less in closing costs. The lender may not order an appraisal since the mortgage is already in place, which will save you a few hundred dollars.

What to consider before assuming a mortgage

A big drawback to assuming a mortgage is the cash you’ll have to pay the seller for their equity. If the home's purchase price was $300,000 and the remaining balance on the loan is $200,000, you could owe $100,000 cash to the seller to purchase the home.

If you don’t have that kind of cash saved, you may have to take out a second mortgage for the difference (which typically comes with higher interest rates and greater default risk).

Another drawback is the loan assumption fee that some lenders charge at closing. This expense alone could add hundreds of dollars to your closing costs.

Bottom line

Mortgage loan assumptions let you take over an existing mortgage with its current terms. It’s a way for individuals to finance home purchases without starting a new mortgage loan. It happens most often in cases of divorce or inheritance.

It could make sense to assume a mortgage if your family member leaves you their home and you can comfortably afford the current mortgage payment. You may then choose to sell your current home to relieve that financial responsibility so that you can take on a new one. You can see what assumable loans are available by your state and ZIP code at www.hudhomeusa.org.

It may not make sense to assume a mortgage if the interest rate is higher than the current market rate, however — you’ll end up paying much more in interest over the life of the loan than if you started a new mortgage loan.

In addition, you wouldn’t want to take on a mortgage payment that you can't afford over the long term. While the lender may approve you for the loan, it may not be a payment you're comfortable with or one that would help you reach your financial goals in the future.