A loan assumption is an alternative to the traditional mortgage loan process. It allows a buyer to assume the current interest rate, repayment period and outstanding balance of an existing loan. Although the process can be simpler, easier and less costly for the buyer, an assumption isn’t a way to circumvent a low credit score and usually is an option only with a few select types of home loans.
Availability and Qualification Requirements
A loan assumption usually is available only with mortgages guaranteed by a federal loan program. These include loans guaranteed by the U.S. Department of Housing and Urban Development, the U.S. Department of Agriculture and the Department of Veterans Affairs. However, some lenders may consider an adjustable rate mortgage still in the adjustable period as a qualifying loan.
Regardless of the type of existing loan, the borrower must meet the lender's qualification criteria, just like for a traditional loan application. Lenders will check the prospective borrower's credit score, debt-to-income ratios and any other underwriting guidelines.
How It Works
In short, a loan assumption usually involves transferring a seller’s outstanding mortgage balance to a new buyer and then subtracting the amount of the assumption from the agreed-upon purchase price. The buyer is responsible for making up whatever difference remains with additional financing or cash on the closing date. For example, assuming a $100,000 loan on a $175,000 purchase would leave a difference of $75,000.
In another scenario, a loan assumption can transfer ownership and the outstanding balance of a loan without selling the home. Although this type of loan assumption can be useful in a divorce proceeding, estate planning or in gifting real estate, it is an option only with an FHA or VA loan.
Types of Loan Assumptions
A lender may offer one of three types of assumptions for a qualifying loan. These are a “subject to,” an assignment and a novation assumption, each of which differs according to the degree the seller remains responsible for repaying the loan if the buyer defaults. According to Financial Web, most lenders offer “subject to” and assignment assumptions, as these reduce most borrowing risks.
"Subject to" Assumption
A “subject to” assumption offers a seller the fewest protections if the buyer defaults. While the buyer will lose any built-up equity, a “subject to” assumption not only leaves the seller fully responsible for the deficient balance of the loan, but also any judgements or liens entered against the property.
An assignment assumption offers a seller more financial protections. Just like with a “subject to” assumption, the seller remains fully liable for paying any outstanding balance if the assumptor -- the buyer -- defaults on an assignment assumption. However, the seller’s obligation extends only to the outstanding balance at the time the default occurs, not for any judgements or liens that may result from the default.
A novation assumption releases a seller from all further personal and financial liability, and therefore offers a seller the greatest protections. The novation creates an entirely new loan obligation that bypasses the seller completely.