Assuming a Mortgage

I am selling my home; and I have a buyer who'd like to assume the mortgage. I understand the risks involved and that is not the issue. I have lived in my house since October 2005, with the original mortgage being through TD Canada Trust. Last June (8months ago), I switched to Servus Credit Union. Last month I did a refinance to consolidate debt incurred from my wedding. My wife and I then made a purchase on a new home; have been approved on the second mortgage with no conditions. Initially, we had a tenant to rent it out. We then decided to sell and we're successful; which leaves us in the current situation. Is there any rules or regulations that prevent and individual from assuming our new refinanced mortgage within 6 months? Or does that rule apply to new mortgage where title has been held for under 6 months? My lender is giving the new buyer grief, and I would like some clarity on this issue. Keep in mind, that my lender has yet to even gather personal information from the new buyer as to whether he is qualified.

Thanks Daniel A.

Hi Daniel,

I have researched it in a million places and received as many answers. Most lenders I have spoken to have said they do not have a specific policy regarding the length of time you must have a mortgage before allowing someone else to assume it. Quite frankly, most have not had the scenario. The main point I hear being emphasized, over and over, is that it is up to them to approve an Assumption. Therefore, your buyer is at their mercy. Given the rapid drop in rates recently, the lender might be more willing to allow someone to assume the loan if it is at a higher rate. Otherwise, the Due-On-Sale Clause that is common on most mortgages (ex-FHA, some ARM's, and VA) pretty much gives your lender the right(s) to negotiate any assumtions and approve or deny them.

I have attached a link and article by Jack Guttentag, Ph.d. While I often disagree with his statements or parts of his writings (Ivory Tower versus real life), this article is excellent:

"When a homebuyer assumes responsibility for a home seller�s existing mortgage, it is called an �assumption�. The buyer assumes all the obligations under the mortgage, just as if the loan had been made to her.

The major driving force behind assumptions is the lower interest rate on the assumed mortgage relative to current market rates. If the home seller has a 5.5 % mortgage, for example, and the best the buyer can get in the current market is 7%, both parties can be better off if the buyer assumes the 5.5% loan. An assumption also avoids the settlement costs on a new mortgage.
For years, we heard little about assumptions because market rates were so low. Now that rates are above their lows, and may rise further, we can expect that assumptions will receive increasing attention.
The value of an assumption depends on the difference in rate, the balance and period remaining on the old loan, the term of the new loan, on how long the buyer expects to have the mortgage, and on the �investment rate� � the rate the buyer could earn on her savings. Assuming that the 5.5% loan has a $100,000 balance with 200 months remaining while the 7% loan would be for 30 years, that the buyer expects to be in the house for 5 years and can earn 4% on investments, the value is about $7,000. A spreadsheet that makes this calculation is available on my web site.
The $7,000 of savings does not include the settlement costs on a new loan. On the other hand, the savings would be reduced if the buyer has to supplement the existing loan balance with a new second mortgage at a higher rate. This could well be the case if the existing loan balance has been paid down appreciably, and/or the house has appreciated since that mortgage was taken out. The buyers who do best on assumptions are those who have the cash to pay the difference between the sale price and the balance of the old loan.
However, buyers should not expect to receive the full value of an assumption. The seller must benefit as well; typically, the parties share the savings. The seller�s share will be in the form of a higher price for the house. Indeed, some economists believe that the full value of the assumption should be reflected in the price of the house, but this is as implausible as the opposite view, that only the buyer benefits.
The benefit to buyer and seller from assuming an old loan comes at the expense of the lender. Instead of having the 5.5% loan repaid, which would allow the lender to convert it into a new 7% loan, the 5.5% loan stays on the books. Back in the 70s and 80s, lenders couldn�t do anything about this. Mortgage notes at that time did not prohibit assumptions, and the courts ruled that lenders could not prevent them.
Following that experience, however, lenders have inserted due-on-sale clauses in their notes. (An exception is FHA and VA mortgages, which do not contain these clauses, as discussed next week). These stipulate that if the property is sold, the loan must be repaid. Even with a due-on-sale clause, the lender may allow an assumption -- keeping the loan on the books avoids the cost of making a new loan � but the interest rate will be raised to the current market rate.
Raising the interest rate to market removes most of the benefit of the assumption to the buyer and seller. In some cases, they attempt to retain the benefit by agreeing to a sale using a wrap-around mortgage, without the knowledge of the lender. The seller takes a mortgage from the buyer, which may be for a larger amount than the balance of the old loan, and continues to pay the old mortgage out of the proceeds of the new one. The new mortgage �wraps� the old one.
This is a dangerous business, particularly to the seller, who has given up ownership of the house but retained liability for the mortgage. The seller is in deep trouble if the buyer fails to pay, or if the lender discovers the sale and demands immediate repayment of the original loan. I wouldn�t do it, even if I were selling the house to my mother.
Instead of prohibiting assumptions, thereby encouraging wrap-arounds, why don't lenders explicitly allow them for a price?
Good question. When interest rates are above their lows and new borrowers are concerned that they could go much higher, some would be willing to pay a premium rate for the right to transfer that rate to a home buyer in the future.
For example, a borrower taking a 6.5% 30-year FRM might be willing to pay 6.875% for the right to allow a home buyer to take it over when he sells his house. The higher rate is akin to an insurance premium. If market rates are above 16% when he sells, as they were in 1981, he will save a bundle.
An assumable mortgage has some resemblance to a portable mortgage. If you sell your home and your mortgage is assumable, it can be transferred to the buyer; if it is portable, it can be transferred to a new property you buy. Portability is of no value if you decide to rent, go to a nursing home, or die, whereas an assumable mortgage retains its value in these situations. On the other hand, some portion of the value of an assumable mortgage must be shared with the purchaser. A mortgage that is both assumable and portable would have enhanced value.
Lenders who offer an assumability option will require that any new borrower meet the lender�s qualification requirements. Borrowers purchasing the option will need to be confident that the lender won�t tighten its requirements when market rates increase. The best assurance would be a commitment to accept approval under one of the automated underwriting systems developed by Fannie Mae or Freddie Mac.
Loans insured by FHA or guaranteed by VA have always been assumable. During periods when borrowers are concerned about future rate increases, this gives them an edge.
FHA loans closed before December 14, 1989, and VA loans closed before March 1, 1988 are assumable by anyone. Buyers who assume these mortgages don�t have to meet any requirements at all, but the seller remains responsible for the mortgage if the buyer doesn�t pay.
Any seller who allows assumption by a buyer without a release of liability is looking for trouble. Even if the buyer pays, and that is a crapshoot, the seller�s ability to obtain another mortgage will be prejudiced by his continued liability on the old one.
WARNING: The release of liability must be in writing, and you must preserve the document. This will protect you in the event that the new borrower defaults and the collection agency comes after you � it knows nothing about your release of liability. This happens!
If an old FHA or VA is attractive to a buyer, the seller can request that the agency underwrite the buyer. If the buyer is approved, the seller will be released from liability. At this point, there can�t be many of these loans left with balances large enough to be attractive to buyers.
Assumption of FHA and VA loans closed after the dates shown above requires approval of the buyer by the agencies. The process is much the same as it would be for a new borrower. Upon approval of the buyer and sale of the property, the seller is relieved of liability. FHA allows lenders to charge a $500 assumption fee and a fee for the credit report. VA allows a $255 processing fee and a $45 closing fee, and the VA itself receives a funding fee of ½ of 1% of the loan balance.
FHA and VA loans that were closed during the low-rate years 2000-2003 will become attractive targets for assumption if interest rates continue to rise. Potential sellers who have one of these loans can use the spreadsheet on my web site to estimate how much the assumption would be worth to a potential buyer.

November 17, 2003

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.