What is an Assumable Mortgage?
An assumable mortgage is a type of seller financing that allows the buyer to take over the seller’s original mortgage. In many cases, an assumable mortgage allows the buyer to purchase a home without having to qualify for a traditional loan. If the seller’s original mortgage has an interest rate lower than what is currently available, the borrower may be able to benefit from that as well.
For example: A seller owns a home with a $100,000 mortgage at 5.5% interest. He sells the home for $150,000 at 6% interest. The buyer must give the seller a $50,000 down payment. The buyer will pay 5.5% interest to the bank and .5% interest to the seller.
The Due-on-Sale Clause
During the late ‘70s, lenders began feeling uneasy about assumable mortgages. They realized that assumable mortgages do not allow them to control who they are lending their money to. The original homeowner may have had a stable job and stellar credit, while the new buyer may be facing bankruptcy.
As a result, lenders began including a due-on-sale clause in their contracts, making assumable mortgages impossible for the majority of transactions.
Most due-on-sale clauses look like this:
“Transfer of the Property or a Beneficial Interest in Borrower. If all or any part of the Property or any interest in it is sold or transferred (or if a beneficial interest in Borrower is sold or transferred and Borrower is not a natural person) without Lender’s prior written consent, Lender may, at its option, require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if exercise is prohibited by federal law as of the date of this Security Instrument.
If Lender exercises this option, Lender shall give Borrower notice of acceleration. The notice shall provide a period of not less than 30 days from the date the notice is delivered or mailed within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by this Security Instrument without further notice or demand on Borrower.”
Basically, a due-on-sale clause says that the lender may call the entire loan due in 30 days if it finds out about the assumable mortgage (i.e. you will have to come up with cash to pay off the entire loan). Lenders won’t always do this, but the possibility is certainly there. In 1982, a federal law was created to make due-on-sale clauses enforceable no matter what state a loan is in.
How Assumable Mortgages Work
There are several ways to make an assumable mortgage work. Here are a few of the most common:
Full Assumption – A seller in poor financial straits simply gives the buyer the title / mortgage and walks away.
Up-Front Payment – The buyer gives the seller a single payment of an agreed upon amount. In return, the buyer is given the title and begins paying the mortgage directly to the lender.
Monthly Payments – The buyer makes monthly payments to the seller. In return, the seller keeps his percentage of the interest and makes a full mortgage payment to the lender each month. The title may be held by either party, depending on the terms of the agreement.
Trust Account – Both the buyer and the seller are made members of a trust controlling the title and the mortgage. Payments are made to the lender each month from the trust account. The seller may also withdraw his take of the interest each month. The title is released to the buyer when the loan is paid off.
Where to Find an Assumable Mortgage
Because of the popularity of due-on-sale clauses, it can be difficult to find an assumable mortgage. Some possibilities include: old mortgages, VA or FHA loans, or risk taking.
Old Mortgages – People holding loans made before the late 70’s may not have signed paperwork with a due-on-sale clause. Consider looking at homes in older, more established neighborhoods where elderly residents have lived for 30-40 years.
VA or FHA Loans – Loans from the Federal Housing Administration and Veterans Affairs are assumable. However, the new buyer must be approved. Generally, the approval process requires a credit check and income verification.
Risky Agreements – Currently, it is very rare for a lender to actually call a loan due because of an assumable mortgage agreement. Some buyers and sellers choose to ignore the due-on-sale clause and make a deal anyway. However, this can be risky. It may not be illegal to create an assumable mortgage, but hiding the arrangement from the lender could be considered fraud.
Assumable Mortgage Alternatives
Assumable mortgages can be a good choice for some borrowers. However, they are notoriously hard to find and do carry some risk. Before deciding on an assumable mortgage, you may want to consider other types of seller financing including wraparound mortgages, carryback mortgages, private loans, and simultaneous closings.