Assumable Mortgages as a Cheap Way to Buy a Property

The assumable mortgage is a type of agreement designed for customers who are selling real estate. The prospective buyer is allowed to assume the loan and benefits from an attractive interest rate and a long repayment term. He assumes the outstanding balance, repayment period, interest rate, and other terms and conditions. This option is less costly and easier for prospective buyers.

Features and Benefits

If the interest rate has gone up, the buyer assumes a low-cost loan, and this reduces the cost of borrowing. The savings vary depending on the interest rate. Another benefit is that an appraisal is usually not required. Financial institutions offer mortgages with a 3-year closed, 1-year closed, and 6-month convertible interest rate, as well as other options. There are loans with variable and fixed interest rates. The payment frequency also varies from bank to bank. Borrowers can choose from monthly, rapid bi-weekly, weekly, bi-weekly, and rapid weekly payment options. Additional payments may be allowed, but some banks charge prepayment penalties. In general, whether it is a good idea to assume a mortgage depends on the interest rate, repayment period, down payment, and repayment schedule.

Closing Costs and Interest Charges

The fact that borrowers pay less in closing costs is one of the main benefits. The closing costs include fees and charges such as survey, recording, inspection, and appraisal fees that increase the cost of borrowing. The repayment period is shorter compared to traditional mortgages meaning that borrowers pay less in interest charges. Homebuyers can choose from adjustable and fixed interest rates, which gives them a degree of flexibility.

Down Payment and Risks

While the buyer saves on interest charges, financial institutions often require additional financing or down payment. The minimum down payment on some loans is 3.5 percent. You can use cash in your savings account, funds gifted by your parents, relatives, or family members, and other sources of income. Your parents should sign a letter which confirms that the funds are gifted.

The financial institution transfers the amount required to the new holder, and the homeowner covers the difference. For instance, if your loan is $120,000, and the homebuyer assumes $75,000, he pays off $45,000. And while the new owner assumes the mortgage, the financial institution can change the interest rate or terms depending on the borrower’s credit and payment history, debt to income ratio, market conditions and state of the economy, and other factors. This type of arrangement carries risks for sellers as well. The original borrower may be held liable in case the buyer is unable to make payments and defaults. For this reason, many borrowers choose to release their liability before they proceed any further. Your credit score would be affected in case of default.

Requirements, Criteria, and Considerations

There are two types of assumptions – creditworthiness and simple. Financial institutions run a credit check but even borrowers with a fair credit score may qualify, depending on other factors. Most financial institutions require a credit score of 620 or higher, but some lenders accept scores of 580 or higher. Even if you meet the requirements, assumable mortgages are relatively rare, and most homebuyers apply for a traditional mortgage. What is more, you need a sizable lump sum to pay the homeowner and assume the loan. And in some cases, the interest rate is higher compared to other loans offered by banks and credit unions. This is a good solution only if you pay up to 20 percent of the purchase price as a lump sum.

While assumable mortgages were more common in the 1980s, today many lenders include due-on-sale clauses in their loan agreements. This means that the outstanding balance must be paid off if the real estate is sold. This provision allows banks to convert the loan into a new mortgage with a higher interest rate. Some financial institutions allow assumptions even with a due-on-sale provision, but this is not a common arrangement. Assumptions are also possible in case of divorce, death, or other major life events. The same is true for two homeowners who co-invested in a property and are joint tenants. Another scenario is when a home is leased for up to 3 years, and there is no purchase option.

Whether you qualify also depends on the date of origination. In addition, creditors look at the borrower’s outstanding balances, including family and child support, student, auto, and consumer loans, and credit card debt. The total amount of your debts will be added to the interest, principal, insurance premium, and property taxes. Your bank will compare your income and liabilities to determine whether you will be able to make payments.

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