If the interest rates of the COVID era are something you’ve wished for in your next home, you should consider if loan assumption is possible for you. Because it’s the best way for motivated buyers to get phenomenal interest rates – even in the low 2%.
Most buyers and sellers have misconceptions about what a loan assumption is and how it works. This post is created to work through loan assumption myths, and to help you identify if it’s right or even possible for your situation.
Boiled down, here is what loan assumption is:
Instead of getting a new loan, a buyer takes over the existing mortgage of the seller. Because most homes are worth more than what is left on the mortgage, the buyer needs to make up the difference with either cash or a combination of cash and new secondary financing.
Real-life example: a home is for sale for $450,000, with an existing FHA loan of $400,000. The buyer will need to have a $50,000 down payment (with all cash or a combination of cash and secondary financing) in order to assume the existing $450,000 loan.
Why would a buyer assume a loan?
If a buyer can assume a loan with a 2.26% interest rate, that’s his interest rate! If the loan only has 25 years left, that’s his remaining term! Even if the buyer has to combine cash and secondary financing, the terms of that financing arrangement may be much better than the current market rates. This typically means that a buyer can lower his monthly payment by $1,000/month or more by assuming an existing mortgage vs. using a new loan at 6.5% (or whatever the current market dictates).
What kinds of loans are assumable?
VA and FHA loans are the most commonly assumable loans. While other loans may be assumed if conditions are perfect, this is very rare and many times impossible.
Why are FHA and VA loans assumable?
FHA and VA loans are government loans. One way that the government is protecting the consumers of its loans is by allowing other parties to take them on. When a new buyer takes on this loan, the seller no longer has to worry about it. It’s additional protection for the seller from defaulting on the mortgage. Instead, the seller can market the current loan, and, when a buyer assumes it, ride off into the sunset, leaving the old mortgage and house behind.
Why would a buyer NOT assume a great rate?
After reviewing the finances, sometimes the numbers do not pencil out. If a buyer does not have enough cash to cover the difference between the sales price and the existing mortgage, or the buyer has to apply for another loan to help bridge the gap, the buyer may decide the deal no longer works. Calculating the numbers early on a loan assumption is very important.
Loan assumption is also typically a longer process than a typical financing transaction. So, maybe a buyer doesn’t want to wait another month or two longer to get the deal done.
How does a buyer qualify for a loan assumption?
Third party companies can help you get pre-screened, so that all of your finances are in order before you contact the mortgage servicing company. This is similar to getting pre-approved for a mortgage by a bank. But different documentation may be required by the servicer. These third parties also help with communicating with the loan servicer, to help the buyer see the deal through to completion.
How does a buyer find these homes with assumable loans?
It’s important to investigate the history of homes that were sold or refinanced in times when the rate environment was more favorable. This is especially the case for homes that were sold from 2020 to early 2022. While you can also look at these public records yourself, my recommendation is to work with an agent that knows loan assumption. There are some tricks of the trade to find which homes are likely assumable. One of these tricks is to look into property records to find out when the loan was originated and what type of loan product was used. Not all existing VA and FHA loans have favorable terms for your situation vs. the current market.
Who can assume a loan?
Investors and regular homeowners can assume VA loans. But if you are assuming an FHA loan, the home you are purchasing has to be your primary residence.
Just like in any lending transaction, a buyer still has to go through underwriting. So the buyer must qualify in order to assume the loan. Typical concerns like credit, debt-to-income ratios, income, and work history are all taken into account.
Why would a seller want to offer a loan assumption?
In many cases, a buyer with additional cash on hand is motivated to get into a home for a lower rate. Especially for those buyers who are current homeowners, getting into a home with a low interest rate is very attractive. Sometimes, buyers are willing to pay a premium for a home – or even look at homes in a bigger price bracket – because of loan assumptions.
Remember that most home buyers are looking through many, many listings before they choose a few to look at in person. A loan assumption offering is a great way to stand out from the crowd and get buyers to look at your home in person.
It’s also important for sellers with an assumable loan to market this opportunity because sellers unlock opportunity for more buyers when they do so. A cash or equity heavy buyer may be able to afford a home that is otherwise unaffordable, due to loan assumption. Marketing this opportunity is a good way to get as many buyers through the front door as possible.
Why would a seller NOT want to offer loan assumptions?
The primary drawback of loan assumptions is the additional time it may take to complete the deal. If a seller is in a distressed situation, where the home needs to be sold tomorrow, a loan assumption may not be the best option. Of course buyers may be willing to help participate in paying a mortgage, etc. in order to take advantage of loan assumption, but timing to close is extended for most loan assumptions.
Another reason is that, with VA loan assumptions, the seller will have the entitlement encumbered by this loan until the home is sold or paid off and the loan is satisfied. This encumbrance may mean that the seller will not see the same extraordinary VA loan benefits when it comes to purchasing the next home.
It is very important to have buyers perform a thorough prescreening, prior to acceptance of an offer.
How is this different from “subject to” purchasing?
This is not a work around. There is no wrap. The seller is not participating in the financing. It’s an exchange. The buyer is being completely upfront with the mortgage company and the seller. The seller releases all liability of the property, and gets to move on with life. The buyer does not simply pay the mortgage… the buyer now has all liability for that mortgage. When the loan assumption is complete, the mortgage is now in the buyer’s name.
Why isn’t Loan Assumption common practice?
Interest rates have been on a downward trend since the 1980s, when interest rates hit over 18%. Since they have largely dropped since then, there was no benefit to acquiring an older mortgage with a higher interest rate. And, since loans went up so high in the 80’s, this was the most recent time when loans were assumed. Buyers at that time occasionally assumed loans with 12% interest rates from the 1970’s.
Now, interest rates again are higher now than they were as recently as 2022. But most buyers don’t know this is an option, or that it’s possible. And, there are many misconceptions that are still being cleared up.
Additionally, lenders who are currently writing new loans do not make any money when old loans are assumed. And, mortgage servicers don’t make much money on assumptions either. So, the financial incentive is not there. As discussed, it’s also not always an option, since only a fraction of current homes have loans that can be assumed.
Loan assumption is still a rewarding option!
At some point, the benefit of assuming an old FHA or VA loan will be gone. Either the amount needed in cash will be too high, the interest rate change will be too low, or the hassle will not be worth the effort. When the juice is not worth the squeeze, loan assumption will again be a thing of the past.
But for now, like most opportunities, being ready to pounce when a good deal arises is the name of the game! It’s a great opportunity for a win-win for the seller and buyer, and is worth the time and effort to investigate.
Give me – John Harding – a call today to get more details and discuss how to prepare yourself for the right loan assumption opportunity: 480-639-9640
