Assumable Mortgages: Set to Get Popular Once Rates Rise

May 21, 2013 3 Comments »
Assumable Mortgages: Set to Get Popular Once Rates Rise

Everyone knows mortgage rates are super cheap right now. And just about everyone believes they won’t last very long at this level.

In fact, tomorrow Ben Bernanke will testify before the Joint Economic Committee regarding the direction of the economy, and he could signal whether QE is likely to continue or taper off.

That may impact mortgage rates, which have already skyrocketed in the past month to 2013 highs.

While they’re still historically inexpensive, the threat of rising rates is all the more reason to lock in a long-term fixed rate today, one that can be held for the next 30 years if need be.

Heck, even Warren Buffett suggests you do that

After all, those who snag a low rate today will not only acquire a highly affordable monthly mortgage payment, but also do so before inflation sets in and makes future payments even cheaper.

[Mortgages vs. inflation]

While this is all good and well for today’s homeowner, what about the prospective homeowners of the future? If mortgage rates and home prices rise in tandem, it’ll be a lot more difficult to purchase a home.

Enter the Assumable Mortgage

An “assumable mortgage” allows a home buyer to take on the home seller’s existing mortgage, including the remaining loan balance, mortgage term, and mortgage rate, as opposed to getting their own brand new loan.

The main purpose of taking the seller’s loan is to obtain an interest rate below the prevailing market rate.

So if mortgage rates increase rapidly in a short period of time, it could be in the best interest of the buyer to see if they can assume the seller’s mortgage.

Example:

Today’s 30-year fixed mortgage rate: 3.5%
30-year fixed mortgage rate in 2018: 6%

If a seller obtains an assumable mortgage at today’s low rates, at say 3.5% on a 30-year fixed mortgage, they can transfer it to a buyer in the future, assuming rates have since risen significantly.

The scenario above isn’t all that far-fetched, and in fact mortgage rates could rise even higher in the next five years.

And you better believe a future buyer would be more than happy to take the 3.5% rate versus the 6% rate. They can also avoid some of the settlement costs associated with taking out a fresh loan.

Of course, if rates remain relatively flat, the assumable mortgage won’t make sense. Additionally, not all mortgages are assumable.

What Types of Mortgages Are Assumable?

These days, most conventional mortgages are not assumable. However, both FHA loans and VA loans are assumable.

Before December 1, 1986, FHA loans generally had no restrictions on their assumability, meaning there weren’t any underwriting hoops to jump through.

And some FHA loans originated between 1986 and 1989 are also freely assumable, thanks to Congressional action that determined certain language was unenforceable.

But let’s be honest, most of those old loans are probably either paid off, refinanced, or have very small remaining balances, so no one in their right mind would want to assume them.

FHA loans closed on or after December 15, 1989 need to be underwritten if assumed, just as they would if they were new loans. In other words, underwriters will need to review a potential borrower’s income and credit to determine eligibility.

Additionally, it should be noted that investors are not able to assume newer FHA loans, only owner-occupants.

VA loans are also assumable, and require lender approval if closed after March 1, 1988, but understand that there are some complicated issues that revolve around VA eligibility.

For example, if the borrower who assumes your VA loan defaults, you may not be eligible for a new VA loan until the loss is repaid in full.

Is an Assumable Mortgage Worth the Trouble?

As you can see, assumable mortgages aren’t entirely cut and dry.

First and foremost, be sure to get a liability release to ensure you aren’t accountable if the borrower who takes over your mortgage defaults in the future.

You won’t want to be on the hook if anything goes wrong, nor have to explain to every future creditor what that “other loan” is on your credit report.

Additionally, understand that an assumable mortgage will likely only cover a portion of the subsequent sales price.

Because the mortgage balance will be somewhat paid off when assumed, and the property value will likely have increased, you’ll either need to come in with a large down payment or take out a second mortgage when assuming a mortgage.

If you need a second mortgage, you should do the math to ensure it’s a better deal with the blended rate factored in versus a brand new first mortgage.

For those thinking they can make money by taking out a mortgage that can later be assumed, it’s probably not advisable to obtain one just in the hopes of using it as a selling tool in the future.

Sure, the buyer may be interested in assuming your mortgage, but they may not be. If you already have an FHA loan, sweet, it may come in handy when rates rise and you decide to sell your home.

But paying costly mortgage insurance premiums on an FHA loan just for its potential assumption value is a fairly big bet to make if you can get a conventional loan for a lot cheaper.

Long story short, don’t assume someone will assume your loan, but don’t overlook it either.

(photo: Andrew Filer)

3 Comments

  1. Scott Celley September 9, 2014 at 2:10 pm -

    How do you search for homes with assumable mortgages?

  2. Colin Robertson September 9, 2014 at 4:23 pm -

    Through your site Scott…right. I also know of a site called Takelist.

  3. Scott Celley September 18, 2014 at 11:07 am -

    Thanks Colin. Good article. Needless to say we agree with you. Interest rates are moving and mortgage assumption will once again become an important aspect of real estate finance.

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