For the home buyer, an assumption loan offers the buyer several important advantages. The primary benefits all save the buyer a lot of money:
- No loan costs
- Avoid loan rejection
- Drastically lesser interest payments
- Shorter term & lower rate
- No down payment opportunity
No loan costs
Homebuyers can avoid loan costs with a mortgage loan assumption. Consider that a new mortgage loan can cost the buyer at least $1,000; sometimes closing costs can add up to 5% of the sales price. By assuming an existing loan, the buyer only has the usual sales expenses and none of the lender and financing charges. This can save the buyer more than $1,000.
However, the buyer must not skimp on attorney costs. Because of the complexity of this maneuver, a competent real estate attorney is absolutely necessary.
Avoid loan rejection
Home buyers can avoid or minimize loan rejection by using the assumption feature. Buyers who have been rejected for financing but still wish to buy a home should strongly consider assumption loans. In many cases, buyers who cannot qualify for a conventional loan may find a solution to their problems with an assumption.
Although many mortgage loans that allow assumption also require preliminary review and approval by the lender of the prospective buyer, their underwriting procedures are often more lenient with assumptions than with standard loans.
Less interest payments
An assumed loan – even if the note’s interest rate is more than current market rates will save the buyer thousands in interest payments. Remember that the bulk of the interest charges on a mortgage loan is paid during the first years of the loan. Regardless of the interest rate on the loan promissory note, your actual interest rate will only be a fraction of that rate.
Another way to look at assumption loans is that, in a sense, the seller has paid discount points for the buyer, which lowers total interest charges.
For example, if a buyer assumes a 30 year loan after the seller has had it for ten years, the seller has already paid much of the interest. The buyer will therefore pay the low monthly payments of a 30 year loan, but with only twenty years of mostly principal payments remaining.
A more direct example of the savings assumptions offer is to compare an assumption of a $100,000 balance on a 30 year loan with only 20 years left and a $100,000 20 year fixed rate loan. Let’s assume that with both options, the interest rate is 10%.
- With the assumption, the buyer will pay $119,679 in interest.
- With the standard 20-year loan will require $131,605 in interest.
- That’s a savings of $11,926 by assuming instead of getting a whole loan.
Shorter term and lower rate
As noted in the preceding example, an assumed loan translates into a shorter term for the buyer without the higher payments of standard short-term loans. During times of high interest rates, assumptions can often be a gold mine of low rates.
The assumption may have a lower interest rate than currently available or, if it is an ARM loan, it has rate caps that wil not allow the rate to increase over current rates.
Even if the loan’s rate are not advantageous, remember that you will not have a full 30 year loan with an assumption, as the seller has already been making payments for a number of years.
No Down Payment Opportunity
In some cases, it is possible to turn an assumption transaction into a no down payment purchase. This can be done by signing a promissory note to the seller for the down payment amount.
The current mortgage is still assumed as normal. However, the balance of the purchase price is owed (instead of immediately paid) to the seller. The seller does become the lender of a second mortgage on the property. At the closing, the buyer will only have to come up with enough funds for the closing costs.
The important selling point of this approach is that a year later, the buyer can refinance the mortgages and consolidate both loans into one new loan. That consolidation refinance will pay off the balance owed to the seller and remove any risk that the original seller was carrying.
For example, consider this example scenario of Jim buying a house from his aunt Martha:
They agree on a sales price of $90,000.
1. Aunt Martha has a mortgage balance of $70,000 that Jim will assume.
2. Jim doesn’t have the $20,000 balance. In fact, he barely has enough to cover the projected closing costs of $2,500. So Aunt Martha accepts a promissory note for the $20,000. No money is exchanged.
3. At the closing, Jim assumes the existing first mortgage and then signs a promissory note of $20,000 to his aunt. Jim then uses what little cash he had to pay the required closing costs. Jim’s new home will have $90,000 in liens.
4. A year later Jim takes out a $20,000 home equity loan to refinance the second mortgage. This refinance loan pays off his $20,000 loan with Aunt Martha, and Jim has bought a home with no down payment.
Another option would be to refinance with a consolidation loan that pays off both the assumed loan and the $20,000 promissory note. Jim could also use this refinance opportunity to pull out additional cash from the property.
Note that this approach can be used even if the seller and buyer are not related – the buyer must merely find a cooperative seller.