Loans insured by the FHA are assumable; conventional loans, with a few exceptions, are not. That means that a home buyer who finances the purchase with an FHA-insured loan and who sells the house later, when interest rates are higher, will be able to offer a potential buyer the right to assume his low-rate FHA loan.
After approval of the buyer by the FHA, the buyer would assume all the obligations of the mortgage upon the sale of the property, and the seller would be relieved of liability. It would just as if the loan had been made to the buyer.
The major force behind assumptions is the ability of buyers to get financing at an interest rate lower than that currently charged by lenders. If the home seller has a mortgage with a rate below the market rate, having the buyer assume the seller’s loan can be better for both. The buyer enjoys a lower rate and avoids the settlement costs on a new mortgage.
The Federal Housing Administration (FHA) allows sellers and buyers to seek assumption in order to benefit both parties. Assumption occurs when the buyer takes over or assumes the mortgage on the home, a mortgage originally obtained by the seller years before. However, the process isn’t that simple.
- Mortgage assumptions are usually sought when the current interest rate offered by the bank is much higher than the rate that the seller originally obtained. Thus, the buyer escapes a higher mortgage payment.
- The lender must approve the buyer before the assumption occurs. The buyer’s credit, income and financial history are examined first. The buyer must also cover the difference between the house price and the balance of the mortgage. This is done using either a second mortgage at the current interest rate or cash.
- FHA loans originating before Dec. 1, 1989, have special considerations. To assume these mortgages, the buyer is not required to prove creditworthiness. However, in lieu of this credit check, the seller becomes liable for the loan if the buyer defaults before the balance is paid. The process is called Simple Assumption.
- To get away from the risks of Simple Assumption, the seller can ask for a release of liability document. Mortgages originating after Dec. 1, 1989, automatically come with such a clause. These mortgages require lender approval before the mortgage can be assumed.
- The point of mortgage assumption is to get a discount on the interest rate. When the mortgage being assumed is significantly less than the price of the home, then the buyer must get a second mortgage or come up with cash. A second mortgage obtained at the current rate often negates the benefits of the assumption, making a conventional mortgage easier.