How to Do a Mortgage Loan Assumption
Taking Over Another's Loan Makes Sense for Some Home Buyers
Mortgage loan assumptions were a popular financing option in the 1970s and 80s but fell out of favor thereafter. Real estate appreciation was strong during the latter time period. Unfortunately, the market dipped in 1991 and crashed in 2008. Before that time, lender requirements were more lenient and many buyers took out 80/20 combo loans, which helped contribute to the 2008 collapse of the housing market.
Moving forward, though, mortgage loan assumptions are finding a place in the real estate market. They are not for every home buyer, and don't fit every seller's objectives. But in some instances, a loan assumption might be the best choice for all parties concerned, providing, of course, that the existing lender will allow an assumption of the loan.
That in itself is the kicker.
Why Some Buyers Prefer a New Loan Over a Mortgage Loan Assumption
- Too much equity
Part of the reason why loan assumptions were not utilized during the late 1980s and early 1990s was because during the boom years, sellers had too much equity and buyers didn't have enough cash to bridge the gap between the loan and sales price. Many sellers were unwilling to do owner financing.
- Low interest rates
Another reason that loan assumptions fell by the wayside for decades was because buyers usually could get a lower interest by taking out a new loan than by assuming the existing loan. It made little financial sense to assume a 7 percent loan when the bank down the street offered 5 percent.
- Alienation clauses
The main reason very few buyers pursued loan assumptions from 1990 through 2009 was because almost every mortgage contained an alienation clause. An alienation clause in the mortgage gave the bank the right to accelerate, meaning demand immediate payment in full, in the event of title transfer.
Before Considering a Mortgage Loan Assumption
The climate needs to be right for a mortgage loan assumption. There are generally three types of loans that allow assumptions: FHA loans and VA loans and bank portfolio loans. Other loans typically call for payment in full in the event the home is sold to another buyer. Sometimes, buyers take title subject to and do not assume the loan. Buying a home subject to can be risky. Before considering a loan assumption:
- Compare interest rates
When interest rates are higher than the existing loan's interest rate, it could make financial sense to assume the existing loan at a lower interest rate. The difference in a monthly payment on $200,000 at 5 percent versus 7 percent is $257 a month. Over 5 years, that's a savings of $15,420.
- Compare loan fees
Because of federal TRID requirements, lenders are required to give borrowers an estimate of closing costs, called a loan estimate. The loan estimate spells out all the costs associated with obtaining a mortgage. Generally speaking, buyers pay a lot more in loan fees to obtain a new loan than it costs to assume an existing loan. The difference could be several thousand dollars or more. Ask the bank to give you a statement containing its loan assumption fees.
- Obtain a beneficiary statement and copy of mortgage
Before taking the seller's word for it and spending money on home inspections, get a copy of the beneficiary statement to determine the unpaid balance of loan and whether the loan is truly assumable. In softer real estate markets, the difference between the unpaid balance and the sales price might be low enough that a 10 or 20 percent down payment will let you pay cash to the loan.
It is wise to consult a real estate lawyer to learn more about your rights and responsibilities before committing to any creative financing options. Nothing is ever a slam dunk anymore.
At the time of writing, Elizabeth Weintraub, CalBRE #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.