Preowned cars. Used books. Secondhand clothing. All of these goods can be smart money-saving purchases. So what about used mortgages?
The idea might sound ludicrous, but in fact, a buyer can take over, or "assume," a seller's mortgage in some cases. The process isn't easy, but both buyers and sellers should know what an assumable mortgage is, when it's desirable and who can benefit.
An assumable mortgage allows a buyer to assume the rate, repayment period, current principal balance and other terms of the seller's existing mortgage rather than obtain a brand-new mortgage, according to James Hines, a spokesman at Wells Fargo Home Mortgage in Des Moines, Iowa.
In theory, any type of home loan could be assumable. However, only two types of typical loans have this feature: FHA loans, insured by the Federal Housing Administration, and VA loans, guaranteed by the U.S. Department of Veterans Affairs. Conventional loans typically are not assumable.
Assuming an existing mortgage can be simpler, easier and less costly for the buyer than applying for a new mortgage, says Lemar Wooley, a spokesman at the U.S. Department of Housing and Urban Development.
Rising rates
The biggest potential advantage for the buyer is that the terms of the seller's mortgage might be more attractive than the prevailing terms the buyer would be offered if he or she applied for a new mortgage. The interest rate is key, though other factors should be weighed, too.
"An assumable mortgage can be very attractive if interest rates are on the rise or the current interest rates are significantly higher than the interest rate on the seller's existing mortgage," Hines explains.
Lender approval
The catch is that the buyer must still apply for the loan and meet all of the lender's requirements as if the loan were newly originated. Without the lender's consent, the assumption cannot happen. That restriction limits the buyer's choice of a lender to the seller's loan servicer.
An appraisal typically isn't required. That might make the deal easier to close and save the buyer the appraisal fee, which could be several hundred dollars. The buyer might choose to obtain an appraisal independently of the lender to mitigate the risk of overpaying for the property.
Another consideration should be the seller's equity. A lot of equity means the buyer must come up with a hefty down payment, Hines explains.
An FHA or VA loan technically can be assumed without the property being sold. That might make sense in connection with a divorce, estate planning or gift of real estate, for example.
Liability release
For the seller, the primary advantage of an assumable loan is that it can make the house more desirable to buyers, especially if the loan has a low rate and the seller has little equity.
Again, there's a catch: The seller might still be responsible for the debt after the buyer assumes the loan. If the buyer doesn't make the payments, the seller's credit could be negatively affected.
"If the lender doesn't release the original borrower from liability for the mortgage, and the assumptor defaults, then the original borrower suffers damage to his or her credit rating," Wooley explains.
VA entitlement
Michael Frueh, director of the loan guaranty services at the U.S. Department of Veterans Affairs, says VA loans have always been assumable because military service members tend to relocate often.
The catch is that a VA loan must be associated with a veteran's entitlement. Consequently, if the buyer isn't a veteran or is a veteran who doesn't have entitlement, the seller's entitlement will remain attached to the loan after the assumption and the seller won't be able to use that entitlement to obtain another mortgage.
"The original veteran needs to be aware that their entitlement will be tied into that loan, unless a new veteran using (his or her own) entitlement buys the home," Frueh says.
Leaving an entitlement attached to an assumed loan also entails a risk that if the buyer defaults, the seller might not be able to reuse that entitlement in the future without a substantial cost.
Remaining entitlement is complicated, so service members are advised to call the VA loan center at (877) 827-3702 for assistance.
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