The cost of getting into the housing market has sky-rocketed over the past year.
The latest rate hike from the Federal Reserve — a modest 0.25 percentage increase compared to previous moves — suggests homebuyers could expect prices to start cooling. But that may take some time. Zillow estimates that a typical American home today still costs 55% more than it would have a year ago.
And with the average 30-year mortgage rate just over 6%, the thought of buying or even selling might be a bit daunting.
In fact, according to Redfin, 85% of people who have a locked-in rate below the current rate are holding back from the housing market. And deals are falling through left, right and center.
But, if you’re looking to move and to somehow keep a lower interest rate, there is a way: an assumable mortgage.
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What is an assumable mortgage?
Like the name suggests, an assumable mortgage allows you to assume an existing mortgage, and that includes the rate. So if you want to buy a house from a seller who has a 4% interest rate, you could buy the house, assume the amount that is still owing on the mortgage and keep that 4% rate.
Sounds pretty good, right? Especially right now.
“If you think about the perspective of a buyer, when rates are low, people are less interested in exploring the possibility of an assumable mortgage if they don't really need to,” said Danielle Hale, chief economist at Realtor.com.
“But now that rates are much higher than they have been, there's a strong incentive for buyers to consider that as a possibility. And for sellers who have a loan that's assumable, to potentially advertise that.”
It’s important to note that not all mortgages are assumable. Loans that are backed by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), or the U.S. The Department of Agriculture (USDA) can be assumable as long as you meet the requirements.
And those who deal with loans backed by the VA say they’re becoming more popular.
“We’re seeing more interest in VA loan assumability as interest rates continue to climb,” said Chris Birk, director of education for Veterans United Home Loans in an email. “Years of historically low rates curbed demand for this under-the-radar benefit of VA loans.”
Deciding whether this arrangement is right for you
There can be a lot of advantages to an assumable mortgage, especially right now.
“During a time of rising interest rates, the benefit of an assumable mortgage is the ability to get a new home and keep the low rate the homeowner locked into months or years prior,” said Birk. “You’re basically taking over someone else’s mortgage loan, including the same principal and interest payment.”
If you’re selling, advertising your home with an assumable mortgage can also make it easier to sell, as lower interest rates are very attractive to buyers worried about the state of the market.
Plus, there tends to be fewer closing costs associated with assumable mortgages. According to the FHA, many of the costs associated with closing can be included in the loan — although you can always pay them out of pocket if you choose to.
However, there are some drawbacks you should be aware of and one of them is that if you’re buying, it could cost you a lot of money upfront.
If you’re looking to buy a house with a price of $500,000 but the loan that you would assume on the house is only $350,000, you’ll have to make up that $150,000 difference, either with a second mortgage, which can be complicated, or with cash.
“You’ll need cash or secondary financing to pay out the homeowner’s equity,” says Birk. “Finding secondary financing can be a challenge. Also, not all VA lenders and servicers allow for assumptions.”
While sellers could potentially make more money off the sale of an assumable mortgage since a lower interest rate might allow them to sell at a higher price, it can also be more tricky.
“You'll have to work with a lender too, regarding whatever the process is for getting that mortgage assumed, if it's even available,” says Hale.
For instance, there are particular rules when it comes to assuming a VA mortgage that can have significant consequences if they aren’t followed.
“There’s also a significant potential drawback to assumptions for the veteran homeowner,” says Birk. “Whatever VA loan entitlement the veteran is using on their current home stays tied up in the property until their original loan is repaid in full. The only way to unlock it in an assumption transaction is for the assumer to be a veteran who is willing to substitute their entitlement for the homeowner’s.”
And if that doesn’t happen, then the veteran's VA loan entitlement for purchases in the future is diminished.
“They may need a down payment or in some cases be unable to use their VA loan benefit at all,” says Birk.
Not all types of mortgages are assumable
Of course, this all assumes that your mortgage is assumable in the first place.
If you’re considering selling and want to know if your loan is eligible, you’ll need to confirm there’s an assumable clause in your contract. That clause will be what allows you to have someone assume your mortgage with all of its terms.
As for buyers, while it’s not the simplest route to homeownership, if you can make it work, right now, it’s probably one of the cheapest.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.