Why Taking Out Someone Else’s Mortgage Is Probably a Bad Idea (Even If the Interest Rate Is Low)
House hunting can easily turn into house fever , especially when home prices continue to rise and you continue to lose the bidding wars for the homes you want. The desire to finally own your own home may push you to make some creative decisions , especially regarding a mortgage, which can be a daunting task at the best of times. When you ‘re crunching these numbers for purchasing your dream home, you might want to look at current interest rates (at the time of this writing, they’re hovering around 7% ) and then look (wistfully) back a decade—the average mortgage rate in May 2013 year was only 3.35% .
If only you could use a time machine to buy your house eleven years ago! And then someone tells you that you can time travel at a lower rate: all you have to do is take over someone else’s mortgage, and it might seem like a magical solution to your house-hunting angst. But there are many disadvantages to an assumable mortgage that make it unlikely to be a wise decision.
How do you accept a mortgage?
Assuming a mortgage is a simple concept: you take over an existing mortgage, agreeing to make monthly payments (including escrow payments) on the same terms and at the same interest rate. The seller transfers ownership of the house to you, you pay him any difference between the price of the house and the loan balance, and bam! You have a home and a mortgage with an interest rate that will allow you to have a much happier time.
For example, let’s say you find a house that’s on the market for $300,000. The seller has an existing mortgage at 4% and a balance of $200,000. You pay the seller $100,000, pay some lender fees, and assume the mortgage while maintaining a 4% rate.
There are two main versions of an assumable mortgage:
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The simple assumption is that it is a private agreement between the buyer and seller, with no lender involved. The seller remains legally responsible for the loan, but the buyer makes the payments and receives title to the home. If the buyer defaults, both buyer and seller are on the hook because the lender has not approved the assumption.
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Assumptions based on novation are more formal and require the lender to approve the buyer for the loan and formally transfer the debt to the buyer. They require more paperwork, but the seller is completely relieved of liability for the debt.
And assumable loans are becoming increasingly popular : 2,221 Federal Housing Administration (FHA) loans and 308 Veterans Administration (VA) loans were accepted in 2022; in 2023, 3,825 FHA loans and 2,244 VA loans were accepted, and we are on track to surpass both of these marks by the end of 2024.
And it could work, yes. If any new mortgage you qualify for has a rate of 6% or 7%, you could save a lot of money by owning that home. If it were that simple, it wouldn’t be difficult. But it’s rarely that simple, for a long list of reasons.
Disadvantages of taking out a mortgage
Trying to take out a mortgage has many potential disadvantages:
Finding one. Your first problem will be finding a mortgage you can take out because most conventional mortgages cannot be accepted. Typically, only government-backed loans from FHA, VA, or the United States Department of Agriculture (USDA) are accepted. These loans make up about a quarter of existing mortgages, so you’re already excluded from 75% of the possible homes you could buy this way.
Strict criteria. If you identify a loan that has the right combination of sales price, loan balance, interest rate, and government support, your next challenge will be strict criteria (unless you make a simple assumption). Assuming novation, you need to contact the lender in the same way as when applying for a mortgage loan. Each government agency has its own set of requirements , including a minimum credit score and requirements that the home be the seller’s primary residence.
No shopping. By taking out a mortgage, you are locked into an existing lender. You can’t go to another bank to get a better deal, and you can’t negotiate any terms – you just accept them as they come. You need to be confident that every aspect of the loan is working for you and feel comfortable not being able to choose the financial institution you work with.
Expenses. If we go back to the example of buying a $300,000 house, assuming a mortgage with a balance of $200,000, you would have to come up with $100,000 to recoup the seller, so you would either pay cash or you would need a second mortgage, meaning that you dilute the benefit of the low interest rate. In addition, there is usually a loan origination fee. For example , the VA charges 0.5% of the remaining mortgage balance .
If you make a simple assumption with a family member or a very close friend who you trust completely, the assumption is that a mortgage could be a way to own a home with a lower interest rate and fewer hassles than taking out a new loan. Otherwise, a mortgage will rarely be the best option, even if the rate is good.