What is a Loan Assumption?
Loan Assumptions: Quick Overview
A loan assumption is a financial transaction in which a new borrower takes over an existing mortgage (with its current terms and interest rate) from the original borrower, effectively “assuming” responsibility for future payments while releasing the original borrower from liability (if the lender approves).
How a Loan Assumption Works
- Identify an Assumable Loan
Not all mortgages are assumable. Conventional loans often contain “due-on-sale” clauses, meaning the mortgage must be paid in full if the property is sold or transferred. However, some government-backed loans (FHA, VA, USDA) are more frequently assumable. Always check the specific loan documentation to confirm. - Lender Approval
Even if the loan is assumable, the lender typically must approve the new borrower’s creditworthiness and income. The new borrower must meet certain lending criteria before the lender formally releases the original borrower from the mortgage. - Financial Benefits
- Potentially Lower Interest Rate: If the mortgage’s existing interest rate is lower than current market rates, the new borrower can save money.
- Closing Costs: They may be lower compared to taking out a brand-new mortgage.
- Faster Transfer: A loan assumption can sometimes close quicker than starting from scratch with a new lender, though this can vary.
- Risks & Considerations
- Original Borrower Liability: If the lender does not release the original borrower in the assumption agreement, that borrower might still be on the hook if the new borrower defaults.
- Equity and Down Payment: The property may have appreciated, so the new borrower might need to pay the seller for the accrued equity, or arrange a secondary loan to cover the difference between the assumed mortgage balance and the purchase price.
- Lender Restrictions: Some lenders impose additional fees or specific requirements before approving an assumption.
Key Takeaways
- Loan assumptions let the new owner continue paying the existing mortgage instead of taking out a new one.
- Not all loans are assumable; check the original mortgage documents and consult with the lender.
- Both parties should ensure the legal release of the original borrower, otherwise they remain financially responsible.
- Interest rates and closing costs might make assumptions attractive if current mortgage rates are high and the existing one is locked in at a lower rate.
