What is Assumability?

With interest rates at record rthlows and FHA mortgages in vogue, this question has never been more pertinent. Simply, assumability is a clause in a mortgage that allows it to be transferred from one borrower to another. In other words, when the original borrower sells the home, he can transfer the mortgage to a new borrower instead of repaying the mortgage.

You’re probably wondering, Why would anyone want to do that? That’s a fair question, since the new borrower will still have to past muster, and the lender won’t sanction the loan assumption unless the new borrower’s credit score is comparable to that of the original borrower. Still, there are two key benefits. The first is that the new borrower can save on closing costs (though there are a handful of small fees) by not having to obtain a new mortgage. More importantly, the new borrower is subject to the original mortgage rate, a lucrative perk if interest rates have risen over the interim. In return for this benefit, mortgages with assumability clauses typically carry slightly higher initial interest rates or require private mortgage insurance.

It is important to understand the three types of assumability, since they are not created equal. An assignmentof a mortgage transfers the obligation to repay, but the original borrower is still on the hook if the new borrower defaults. With a subject-toassumption is similar to an assignment, the original borrower is also responsible for any deficiency judgements (i.e. second mortgages) in the event of default. A novation transfer absolves the original borrower of all responsibility even if the new borrower defaults. Unlike an assignment and subject-to transfer, a novation is the only kind of assumption that doesn’t carry risks for the original borrower.

Generally, assumability clauses are only present in FHA and VA loans. It doesn’t hurt to ask your lender if it can be inserted into your loan, but in practice, most lenders would be reluctant to do so. Still, it’s worth understanding the trade-off with assumability. As long as interest rates have risen (enough to offset the PMI premiums) when you sell your home, then assumability will inure to you as a net benefit. Over time, however, the value of assumability decreases, as home-price appreciation and a decline in your mortgage balance make it unlikely that a new borrower will be able to afford to assume your loan. Ultimately, if your loan is assumed, the benefits will be shared between you and the original borrower.

Without introducing precise numbers, suffice it to say that the sweet spot for assumability is probably between 3 and 7 years. As one expertsummarized, “Short of three years, it is not clear that interest rates will be significantly higher than they are today, and after seven years, it is not clear that assumability will have significant value to home buyers.”