Understanding Assumable Mortgages: How They Work and What Buyers Should Consider

An assumable mortgage provides an enticing opportunity for Chicago homebuyers to not only acquire the seller's property but also take over their existing loan. This means that the new homeowner assumes the remaining loan balance, repayment schedule, and interest rate.

Assumable mortgages become especially appealing when interest rates have risen. Consider a scenario where a house was purchased in January 2021 when the average 30-year Fixed Mortgage rate dropped to 2.65%. A buyer acquiring the property through an assumable mortgage in January 2024 (with an average 30-year Fixed Rate of 6.61%) could benefit from an interest rate approximately 4 percentage points lower than the prevailing market rates.

It's important to note that only government-backed mortgages, such as those insured by the Federal Housing Administration and the Department of Agriculture, qualify as assumable mortgages. Additionally, the buyer may need to cover the difference between the mortgage balance and the current value of the home, potentially requiring a second mortgage. In this article, we delve into how assumable mortgages work and outline the advantages and disadvantages for both buyers and sellers.

What Is an Assumable Mortgage?

An assumable mortgage is a home loan that can be transferred from the original borrower to the subsequent homeowner. The interest rate and repayment terms remain unchanged. For example, if a 30-year mortgage is three years old, the new borrower assumes the loan with 27 years left, effectively changing only the name on the mortgage documents.

Which Mortgages Are Assumable?

Not all mortgages can be assumed during a home sale. Buyers can assume federally guaranteed or insured mortgages, including:

• FHA loans, backed by the Federal Housing Administration.
• VA loans, guaranteed by the Department of Veterans Affairs, which do not require the buyer to be a veteran or in the military.
• USDA loans, guaranteed by the Department of Agriculture.

How to Assume a Mortgage

Assuming a mortgage requires the lender's approval. Informal assumptions without the lender's knowledge can pose risks, as the lender may demand immediate repayment of the entire loan amount. A proper assumption involves the new borrower meeting similar criteria as required for a new loan, including credit checks and financial information. Once approved, the original borrower's liability for the debt is released.

In cases where the buyer assumes a $200,000 mortgage on a property currently valued at $450,000, negotiations with the seller may be required to determine how and when to settle the $250,000 difference, which the seller could request upfront.

Advantages of Assumable Loans for Sellers

• Easier Sale: Assumable loans make homes more attractive to buyers, especially if interest rates have increased since the loan's origination.
• Higher Price: Sellers can negotiate a higher sale price, as buyers take on a lower interest rate and reduced closing costs, often applying the savings to a second mortgage.

Advantages of Assumable Loans for Buyers

• Lower Interest Rate: Buyers benefit from access to lower interest rates that may be unattainable in the current market.
• Lower Closing Costs: Assumable mortgages typically come with more affordable closing costs and may not require a new appraisal, saving buyers money.

Disadvantages of Assumable Loans for Sellers

• VA Entitlement: Sellers with VA loans may encounter difficulties if buyers assume their mortgages, as the seller's VA entitlement might remain tied up with the assumed loan, limiting their ability to secure another VA loan for a new home purchase.

Disadvantages of Assumable Loans for Buyers

• Large Down Payment: Rising home values can necessitate a second mortgage to cover the difference between the assumed mortgage amount and the current property value.
• FHA Stipulations: FHA loans have specific criteria for new owners who assume the mortgage, including income and credit requirements.
• Mortgage Insurance: FHA loans may require monthly mortgage insurance payments for the loan's duration, diminishing some of the advantages of the lower interest rate.

Assuming a Mortgage After Divorce or Death

Assumable mortgages can also occur outside of home sales, such as when one spouse assumes the loan following a divorce or the death of the other spouse. In these cases, the remaining borrower must demonstrate the ability to make the monthly payments, and approval is not automatic. If the original loan note included both spouses, the lender may want to ensure the remaining borrower qualifies independently.

In summary, assumable mortgages offer a unique opportunity for both buyers and sellers, with potential advantages and disadvantages that should be carefully considered in the context of the current real estate market and individual financial situations.