If you’re considering owner financing, you’ve likely heard the term “assumable mortgage.” But what does it mean? And what are potential pitfalls of using one? Read on to learn all you need to know.
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What Is an Assumable Mortgage?
An assumable mortgage is a type of conventional home financing that allows the mortgagor (the person who took out the loan) to transfer the loan to the buyer of their home.
Notably, the assumable mortgage helps you break tradition, as the buyer can take over the mortgage of the seller so long as the lender approves. Not all loans are assumable though.
They are usually only approved for FHA and VA loans, and even if they are, there must be more than 20 years left on the mortgage.
Pros and Cons of Using One
Pros (what we like)
The key benefit is the interest rate – if rates were lower at the time of purchase than in the current market, then the buyer benefits. When a buyer assumes a mortgage, it also cuts down on closing costs as third parties like estate agents are not involved in the mortgage transfer.
Since few mortgages are assumable, the seller may also benefit by using the assumable mortgage to attract potential buyers. Because the seller is offering a lower mortgage rate than banks, the can possibly negotiate a price closer to current market value. It’s a win-win for both buyer and seller.
Cons (what we dislike)
If the mortgage being assumed is paid down, the buyer needs to pay the difference out of pocket. If they can’t pay cash, they need to take on a second mortgage.
For example, say a home is $300,000 but the assumable mortgage is $200,000. The buyer needs to bridge the $100,000 gap. Of course, most banks want first lien on their loan.
So the buyer may have trouble securing secondary financing without making a large down payment on the second loan – most lenders require significant home equity in order to make a loan in second position.
Many banks don’t even issue second mortgages on homes with assumable first-position mortgages. Another downside is that the seller can be held responsible for the loan being assumed, even if the sale has already occurred.
The reasoning behind this is because the original homeowner took out the loan in their name, so they are the one that should be held responsible. For this reason, we don’t suggest selling your home without the buyer obtaining their own financing.
Should You Use an Assumable Mortgage?
While there are certainly benefits to selling a home with an assumable mortgage, we don’t recommend it. After all, a buyer interested in this type of financing is either very astute (and wants to benefit from the lower interest rate) or can’t qualify for a traditional bank loan.
While you are opening yourself up for liability in either case, the latter category of buyer should put you on alert.