Mortgage Assumption: How it Works and Understanding its Pitfalls
If used properly, mortgage assumption can provide valuable benefits for both the buyer and the seller. If used improperly, however, they can be a bane for both parties, as well as illegal.
Let’s start with the basics: What is meant by the term “assumed mortgage?” In a nutshell, the assumption of a mortgage is just what it sounds like- the transfer of all liabilities associated with a mortgage from one party to another. There are several variations, but it basically refers to a situation in which the buyer of a home assumes the existing mortgage from the seller, in lieu of taking out a new mortgage.
The benefit of such an arrangement is cost savings. Especially if interest rates have risen in the interim (i.e. in the time that has elapsed since the mortgage was initially obtained), the savings can be significant. Even with significant changes in interest rates, there are savings associated with not having to pay closing costs associated with obtaining a new mortgage. A buyer whose credit is less than stellar meanwhile, can avoid negotiating with a bank, and instead negotiate directly with the seller. Typically, any savings are shared between the buyer in the seller, and are simply tacked on to the price of the home.
Historically, mortgage assumption was only ever popular during times of interest rate uncertainty, namely the 1980’s and early 1990’s. At that time, many mortgages were assumed privately. In other words, the transfer was negotiated directly between buyer and seller, without the knowledge of the lender. Such mortgages are often structured as wraparounds, whereby the original mortgage is maintained by the original borrower, who receives payment from a new homeowner at a spread to the original borrower. Nowadays, such assumptions have become the exception, since lenders have caught on and inserted due-on-sale clauses into mortgages, which essentially required them to be repaid in the event of a change of ownership on the underlying property. Failure to notify the lender of a mortgage assumption, in such a case, qualifies as mortgage fraud.
Some lenders have become more amenable to mortgage assumption, such that they are willing to honor a transfer to a new borrower without assessing fresh closing costs. The catch is that in the process, the interest rate is ratcheted up to conform with prevailing rates. [Otherwise, the lender would deprive itself of the income that it could earn from charging a higher rate]. It should be noted that FHA and VA loans are always assumable, although those originated after 1989 require the approval (and payment of certain fees) of the lender.
If private mortgage assumption strikes you as incredibly risky, that’s because it is! While a public (i.e. lender-approved) assumption relieves the original borrower of all liability, private mortgages are off-the-record (and often illegal) and hence must be resolves directly between the two parties involved. Failure by the new borrower to make timely payments would place the original mortgager in the awkward position of playing landlord, perhaps to the point of executing a form of foreclosure. Meanwhile, mortgages that are assumed multiple times still leave the borrower (and his credit rating) on the hook until for as long as the mortgage remains existence, as one borrower learned the hard way.
In today’s ultra-strict lending environment, chances are you won’t ever have to deal with mortgage assumption. Given that rates are projected to begin rising, however, it could conceivably experience a modest surge in popularity. Still, for the average borrower, it’s not something worth considering.
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