Homebuying decoded: What is an assumable mortgage?

Discover how this kind of mortgage can offer lower interest rates   and simplify the homebuying process — plus pros and cons to consider.

Many homebuyers have been put off by the relatively high interest rates of the past few years. What’s one way to avoid those high rates on a home purchase? Find a seller with a lower interest rate and assume their mortgage. This may sound outlandish, but 23 percent of active mortgages — or 11.6 million loans —are currently “assumable.” 

Let’s explore what that actually means.

What is an assumable mortgage?

An assumable mortgage is a type of home loan in which an outstanding mortgage and its terms are transferred from one person to another without any changes to the original agreement.

This type of arrangement is commonly used in a divorce or with an inheritance, where one party assumes responsibility for a mortgage that may have been previously held by a former spouse or family member. It can also be advantageous in situations when interest rates are higher than they were at the time of the original purchase. By assuming the previous owner’s mortgage, the buyer can take on their lower interest rate, too.

However, it’s important to note that not all mortgages are assumable and that the buyer may need to pay the owner for any equity they’ve accumulated in the home, which can be considerable.

What types of mortgages are assumable?

Most government-backed mortgages are assumable, including those issued by the Federal Housing Administration (FHA), Veterans Affairs (VA) and U.S. Department of Agriculture (USDA). In most cases, conventional (or private) loans are not assumable.

• FHA loans: All FHA loans are assumable, but the terms of assumption can vary. Under the HUD Reform Act of 1989, buyers looking to assume an FHA mortgage on a home purchased after December 15, 1989, must prove creditworthiness as established by the lender. Homes purchased before 1989 generally have no restrictions on assumability, which means that buyers can assume the mortgage no matter their credit score.
• VA loans: VA loans (those offered to veterans, active-duty military and select surviving spouses) that were issued after 1988 are assumable, and the buyer doesn’t need to be a veteran. But, as is the case with FHA loans, the lender must approve the buyer’s creditworthiness.
• USDA loans: Assuming a USDA loan can also be an attractive option, but the buyer must meet the eligibility requirements for the loan, including making below a certain income threshold. (This threshold is based on where you live and can be calculated on the USDA website.)

What are the benefits of assuming a mortgage?

When a buyer assumes a mortgage, they avoid having to go through the process of obtaining a new home loan. Instead, they simply keep the seller’s mortgage, including the principal balance, repayment period and interest rate. And, again, when interest rates are high, assuming a mortgage can be a more affordable option for buyers.

For example, if the original owner has 27 years left on a 30-year mortgage with a fixed interest rate of 3 percent, the next owner will take over payments on that very same mortgage. 

What are some of the disadvantages of assuming a mortgage?

One downside to assuming someone’s mortgage is that the loan you’re taking on may not be large enough to cover the home’s current market value, which could leave you responsible for paying the difference.

Say, for example, that the current owner purchased their house a decade ago for $300,000, put $10,000 down and took out an FHA loan for $290,000. They have since paid the loan down to $230,000. But now, due to the run-up in real estate prices, the home is worth $500,000 ($270,000 more than the mortgage balance). As the buyer, you will only assume the $230,000 remaining on the mortgage. So, you will still be on the hook for the $270,000 difference and would need to put down cash or take out a second mortgage to cover it.

If you have two mortgages, you’ll need both lenders to cooperate on granting the terms of service, which is not always possible and can ultimately result in defaulting. You may also need to obtain loan insurance — which, with FHA loans, can be significant.

Assumable mortgages can have drawbacks for sellers, too. The seller may remain legally responsible for the mortgage even after the sale, unless the lender specifically releases them from the obligation.

And, in the case of VA loans, the seller might have to give up their right to an “entitlement,” which is the guarantee that the Department of Veterans Affairs makes good to the lender if you default on your mortgage. In many cases, this entitlement allows veterans to purchase homes with zero percent down.

(If you assume a VA loan, the interest rate typically remains unchanged, but you may need to pay a funding fee to the VA loan program.)

If you, as the seller, sell your home to another veteran, you can ask them to formally substitute their entitlement for yours on the mortgage. But if you sell to a civilian, you may lose access to all or part of your entitlement on future home purchases. 

Dig into articles, tools and resources for first-time homebuyers, and find a U.S. Bank mortgage loan officer to help you on your homebuying journey.