Today’s real estate market is a complicated one. We’re facing a historic shortage of homes, and that’s driven prices through the roof. Not only that, but mortgage rates have hit levels we haven’t seen in decades. This combination of record home prices and high interest may make homeownership seem unattainable in the short term. It’s a tough time for prospective first time homebuyers.
If that describes your situation, but you’re still ready to take the plunge, you’ve got options. It may make sense to take over for someone with a lower rate through a mortgage assumption agreement. What’s that you ask?
A mortgage assumption agreement is a tool we can use to purchase real estate at more agreeable terms. If you’re new to the concept, not to worry. We’ll take a look at what mortgage assumption agreements are, how they work, and whether or not they’re worth it.
What is a Mortgage Assumption Agreement?
Basically, a mortgage assumption agreement is a type of loan assumption agreement that applies to mortgages. It allows a buyer to “assume” or take over a seller’s mortgage. The buyer will now be responsible for making the payments and assumes ownership when they make the final payment. It sounds like a great solution, but many people find the concept daunting.
So, how does a loan assumption work? It’s a simple concept with a potentially complicated process, but it’s certainly doable. It all depends on what type of agreement you enter into. There are two main types of mortgage assumption agreements.
A simple mortgage assumption agreement is one where the buyer simply takes over payments for the seller. The title is transferred, and there is little involvement by the lender. This can be a risky agreement, however. Since the buyer isn’t obliged to the lender for making payments, the seller is at risk of facing consequences. These could involve negative credit reports or even repossession of the home. Sellers should only enter into this type of agreement if they trust the buyer to make timely payments.
The other type of mortgage assumption agreement is a novation. In this type of agreement, we work with lenders to legally substitute the buyer for the seller on the mortgage. When creating an assumption letter for mortgages, the loan terms remain the same, but the responsibility for payment changes hands. This is a much cleaner, legally binding method of loan assumption.
Securing a Mortgage Assumption Agreement
There are a lot of things that go into securing a mortgage assumption agreement. You’ll still need to have your financial ducks in a row. It also takes some time to go through. But taking the time and making the effort could save you a decent chunk of change. Let’s look at how mortgage assumptions work, as well as some pros and cons of entering into an agreement.
Find Out if a Mortgage Assumption Agreement is Even Possible
The first thing you’ll want to do is make sure the seller has an assumable mortgage. Some loans qualify, while others don’t. What is an assumable mortgage? Let’s take a look.
As a general rule, only government-backed mortgages qualify as assumable mortgages. There are some exceptions to the rule, but these types of loans are a pretty safe bet. However, some do come with stipulations. For instance, Veterans Affairs only allows mortgage assumption agreements between current or former members of the military or surviving spouses. You’ll want to do some research before contacting the lender.
Many private mortgages include a clause indicating that the balance is due upon transfer to a new buyer. This is known as a due-on-sale provision. In this case, it’s very hard to qualify for an assumption, but not impossible. We’ll touch more on the circumstances where you could still qualify a little later on. The exceptions mostly relate to transfers of property within the same family.
Make Sure You Have Enough for a Down Payment
If a mortgage assumption sounds like a good fit, you’ll need to have the funds to buy out the seller. With an assumable mortgage, no down payment is necessary, in the traditional sense. But that doesn’t mean you can get yourself a new home with zero down.
Let’s say you are taking over a $250,000 mortgage, and the seller has already made $100,000 in payments. They will not want to lose out on the equity they’ve built. You’ll need to make sure you have the funds to cover that amount as a down payment.
Sometimes covering this down payment will require taking out a separate mortgage. If you’re going to need a mortgage to cover these costs, you’ll need the ability to cover two monthly payments.
Get Started Early
The loan assumption process can take a long time. Many will take 45-90 days, so the sooner you get started, the better. You will still have to complete some of the same steps you would have with applying for your own mortgage. They will generally require a credit report, along with financial and employment information. Making sure you have things like W-2s and pay stubs at your fingertips will make the process much easier.
Taking Over a Mortgage from a Family Member
Let’s say the mortgage you want to take over belongs to a family member. This can be a great way for first time homeowners to break into the real estate market. Any assumption of debt agreement can be substantially easier to finalize if it is made between family members. You may even have a legal right to a mortgage assumption agreement, even if the lender included a due-on-sale provision.
If that family member is a spouse, you have some legal legs to stand on. Even if the loan has a due-on-sale provision, a spouse has a legal right to assume the mortgage. If you get divorced when interest rates are high, this can be a life saver. It also means you can keep your home, even if you can’t secure financing for a mortgage of your own.
If you’ve just inherited a property, federal law requires that lenders allow you to assume the mortgage. It doesn’t matter what kind of mortgage it is. You aren’t required to assume the mortgage, but they are required to give you the opportunity.
The Pros of Mortgage Assumption
Since mortgage assumptions still require us to put in some legwork, you may wonder what makes them so appealing. It’s a valid question. While it’s not always the best course of action, there are circumstances that make an assumption particularly attractive.
There are fantastic monetary reasons for entering into a mortgage assumption agreement rather than applying for a new loan. First, you can save a lot of money on your interest rate. If the current homeowner bought when rates were much lower, you can assume the mortgage at that rate. With the high rates currently being offered, this could save you hundreds of dollars each month.
Additionally, there are some things that can be reduced or omitted when assuming someone else’s loan. For instance, closing costs can be significantly reduced, and there likely won’t be a need for appraisals. As a seller, these monetary benefits may entice a buyer to choose your property over another.
Easier to Qualify
If you’re having trouble qualifying for the financing you need, an assumption may get you into that new home. Since the loan amount is likely greatly reduced, you won’t necessarily need to meet the same requirements.
The Cons of Mortgage Assumption
Unfortunately, getting into a loan assumption isn’t all positive. There are some potential risks associated with entering into this type of agreement. Now that we’ve covered some of the great advantages associated with mortgage assumption agreements, let’s get to the downsides.
Possibly Higher Interest Rates
While a mortgage assumption agreement could net you a lower interest rate, the inverse is also true. If the seller purchased the home when rates were considerably higher, you’d be better off with a mortgage of your own. Before making your decision, carefully weigh the current interest rate against the one the seller has already secured.
Larger Down Payments
Another downside to mortgage assumption agreements is that you’ll have to come up with more money on the front end. Rising home prices mean that many sellers have quite a bit of equity in their homes. If they’ve already got 30 or 40% equity, that will make for a substantial down payment. If you need to cover that, it may make the home unaffordable. However, if you’ve got cash to make it happen, it may get you a new home at a great rate.