Many potential buyers mistakenly believe that an assumable mortgage is the best way for a person with poor or bad credit to buy a house for which they would otherwise not qualify. However, as it turns out, this is just a myth. LTK recently spoke with Mark Jones of AmeriFirst Home Mortgage to get the whole story about assumable home loans and how these loans affect buyers and sellers.
About Mark Jones
Mark Jones and his partner Dave Gahm have been in business for over 25 years. Their business, AmeriFirst Home Mortgage, is a small regional mortgage bank. Prior to entering the field of banking, Mark earned a Bachelor's Degree from Virginia Commonwealth University in Business Administration and Management.
What Is an Assumable Mortgage?
LoveToKnow (LTK): Explain an assumable mortgage in plain English (with no technical jargon) for our readers.
Mark Jones (MJ): An assumable mortgage is simply a mortgage that can be taken over by a third party and leaves the terms and conditions of the original mortgage in place.
LTK: Are all mortgages assumable?
MJ: Actually, no. Most mortgages are not assumable. All loans now have in the language of the note and the mortgage what is called a "due on sale" clause. That clause requires the loan to be paid off if the property is ever sold and is what prevents the assumption of the loan. There is an exception to that in the case of government loans, and I'll address that later. In actuality, we have not had a request for a formal assumption in over a decade.
If there is a formal assumption of the loan, which means the seller notifies the servicing lender, the buyer qualifies for the loan, and the lender approves the loan, then an assumption does relieve the seller from any future liability for the loan.
Types of Assumable Home Loans
LTK: You mention a formal assumption. What is an informal assumption and what are the risks?
MJ: In an informal assumption, if there were no due on sale clause in the language of the mortgage note, I could assume your loan from you without ever letting the servicing lender or the FHA know. I would just basically take over your payments. The problem with an informal assumption is that you (the seller) are still technically liable for that loan. I'm just making payments on your behalf, so you are basically putting your credit standing and rating in my hands. Informal assumptions caused a lot of problems back in the 80s, and that is why they closed that loophole.
LTK: Are there any other risks to an informal assumption?
MJ: Informal assumptions are technically not allowed. If you take over payments on someone else's mortgage without notifying the servicing lender and they find out, it immediately accelerates the loan and makes it due and payable on demand. That's dangerous ground for the seller and a good reason to avoid doing an informal assumption.
LTK: Can the person who assumes a mortgage refinance it?
MJ: Yes, they can, but only on a formal assumption.
Advantages and Disadvantages
LTK: What is the advantage to someone assuming a mortgage? What is the downside?
MJ: The major benefits are more favorable rates and lower closing costs. The disadvantage is the person who assumes the mortgage has to cash out the seller's equity. If a seller has built up a considerate amount of equity, this could be a large sum.
LTK: What is the risk of allowing someone to informally assume your mortgage?
MJ: As we discussed earlier, you are allowing someone else to be responsible for your credit score. If the assumption is discovered, you could find yourself liable for the balance of the loan to be paid in full because of the due on sale clause. In a nutshell, formal assumptions are advisable, but informal assumptions are risky business.
Assumable Mortgages Fast Facts
LTK: Does the person who wants to assume the mortgage have to qualify?
MJ: Yes, they do. The seller would contact the servicing lender to notify them that they have a buyer who wants to assume the mortgage. The buyer would have to go through a credit standards check just like anyone who is applying for a mortgage and would have to meet the same credit criteria as someone getting a new mortgage. In essence, the lender who holds the mortgage has to approve the assumption.
LTK: Are most assumable mortgages fixed or adjustable rate mortgages?
MJ: There are some FHA loans with adjustable rates but most are fixed rates.
LTK: What types of fees or closing costs does the person who assumes the mortgage pay?
MJ: There is generally an assumption fee, updated title work, and the closing attorney's fee, which all totaled is usually less than $1000. That's about one-fourth to one-third the cost of closing a new mortgage. Part of the assumption fee is so the servicing lender can put the buyer through a qualification process. If they qualify, the seller gets a release of liability.
LTK: Is it true that most assumable mortgages are FHA loans?
MJ: Yes, it is. Presently, the FHA (and VA) will allow assumptions by a qualified buyer. This is referred to as a formal assumption, which means the buyer has to come in and actually apply with the current servicing lender.
Risk Versus Rewards
LTK: What have I forgotten to ask that you think our readers need to know?
MJ: I think we have pushed this point throughout the interview, but I want to reiterate that doing an informal assumption is risky. There may be some temptation out there to do one because someone's credit is poor and they might not qualify for a formal assumption. You know, it's risky business.
First, you are doing something that is in violation of the note you signed. You take a chance of triggering the acceleration clause. Secondly, if that person doesn't make the payments on time, those are your payments and not theirs. You are allowing someone else to impact your credit standing, which by today's standards is huge. You need to protect your credit rating at all costs.
The Bottom Line for Buyers
When market rates are rising, the lower interest rates on an assumed mortgage may provide the best rate you can get. However, in times when mortgage rates are low, prospects for assumable home loans generate less interest. Benefits of assuming a mortgage need to be thought out and measured. Ask questions like:
- What is the difference between assuming the mortgage or obtaining a new loan?
- What is the balance and period remaining on the existing loan versus the term of the new loan?
- How long do you expect to have the home?
- With that in mind, what is the rate you can earn on savings from the lower rate?
One additional benefit to take into the decision making process is that when you assume a home loan, you'll avoid some settlement costs that you would have to pay on a new mortgage.
Do Your Due Diligence
Don't presume an assumable mortgage is your best option until you do the math and calculate the financial benefits of assuming an existing loan versus applying for a new mortgage. Check out assumption fees and have a professional read over the existing contract for any other conditions of assumption that will apply. Your safest choice is to research the various types of mortgages completely before you make your final decision.
Learn More About Mortgages
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