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An assumable mortgage is a type of mortgage program that allows you to transfer your mortgage loan to the new buyer of your house.
A mortgage assumption might appeal to potential buyers in the rising interest rate environment. Your current low-rate mortgage (compared to the market rate) will be attractive to potential buyers.
An assumable mortgage is a type of mortgage program that allows you to transfer your mortgage loan to the new buyer of your house.
In order words, you are selling your house and the mortgage loan as one package.
The new buyer accepts to take over your property and mortgage debt by assuming your mortgage.
The buyer will now be obliged to make the required monthly payments on the mortgage loan. However, you will only be freed from the mortgage loan liability after the new buyer has made consistent payments for a minimum of 12 months.
If you buy your house with a mortgage loan, you have to apply and get approved for the mortgage loan. The mortgage loan comes with the monthly obligation to make consistent interest and principal payments.
In addition, if the mortgage is default-insured, you will have to pay the default insurance premium as part of your monthly mortgage payment.
If you decide to sell the house before the end of your mortgage term, you may use the assumable mortgage option to transfer the mortgage loan to the new owner.
Getting the new homeowners to assume your current mortgage terms will let you off the hook for paying the prepayment penalty, which can amount to tens of thousands of dollars.
An assumable mortgage allows the new buyer to assume the terms of the mortgage as it is. That new buyer will assume the mortgage balance, the interest rate, the mortgage term, and other aspects of the contract.
A mortgage assumption can appeal to buyers since it enables them to skip the headache of going through the rigorous process of seeking a new mortgage loan.
An assumable mortgage has the following features:
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Before mortgage assumption can occur, your lender must review and approve the new buyer.
If the mortgage is default-insured, your default insurance provider must review and approve the new buyer.
As you were evaluated and approved for the mortgage, the lender will review the new buyer’s credit score, credit repayment history, income ratios, and down payment (if required) sources.
Likewise, you must be up to date with your mortgage payment to allow the mortgage assumption to be processed smoothly.
If the buyer is approved for the mortgage assumption, the lender will then complete the transfer of the contract and the property title to the new buyer. The new buyer must pay the difference if the property value exceeds the outstanding mortgage balance.
In Canada, your liability of the mortgage loan will only be fully released after 12 months of consistent mortgage payments by the new owner.
Before entering into a mortgage assumption transaction, speaking with an expert mortgage professional or even a licensed real estate lawyer is advisable.
A mortgage assumption might appeal to potential buyers in the rising interest rate environment. Your current low-rate mortgage (compared to the market rate) will be attractive to potential buyers.
When selling your house, you can use your assumable mortgage to incentivize potential buyers, especially in periods of rising mortgage interest rates. You can use a low mortgage rate to incentivize potential buyers. They can save thousands of dollars if your mortgage still matures for a few years.
For example, a $425,000, 3-year fixed-rate mortgage offered at a 3.59% rate would result in monthly payments of $2,142.14, and the total interest you will pay over the 3-year term will be $43,730.60.
The same mortgage offered at a 1.89% rate will result in monthly payments of $1,777.19 and a total interest payment of $22,885.88 over the 3-year term. The buyer will save $20,844.72 by assuming your mortgage and the reduced monthly payment obligation.
While an assumable mortgage benefits the buyer and seller, there are also disadvantages.
There is usually a penalty when you pay off all or part of your mortgage before the end of the contractual term. You have to note if your mortgage has an Open or Closed term. You can prepay an open-term mortgage in whole or part without a prepayment penalty.
On the other hand, you cannot prepay, refinance or renegotiate a closed mortgage before the end of the term without a prepayment penalty. These penalties can amount to tens of thousands of dollars. One way to escape this penalty is by getting someone to assume your mortgage.
As explained above, one of the main motivations for a buyer to assume your mortgage is to enjoy your low-interest rate. Mortgage assumptions are more attractive in a rising interest rate environment. Low interest will make your property more marketable if the buyer can assume your current mortgage.
Another attractive point for an assumable mortgage to potential buyers is to escape the rigorous mortgage search process.
The proliferation of rate comparison websites makes this advantage less appealing as it is now more accessible for people to compare rates online.
However, your assumption mortgage will attract buyers with not-so-good credit and income profiles as it helps them avoid the rigorous underwriting process.
They will still go through the regular mortgage underwriting and approval process.
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The biggest drawback to assuming a mortgage is that the buyer needs to provide a higher down payment amount than they would need when applying to get their mortgage.
The buyer will have to repay the money you put down when you first bought the house and reimburse you for any of the built-in equity or the appreciated value of the property.
For example, you bought the home for $500,000.00, of which you made a down payment of $25,000.00, and got a mortgage loan of $475,000.00 when you purchased the house two years ago.
If the house is now valued at $550,000.00, the buyer will reimburse the $25,000.00 down payment and pay you the $50,000.00 appreciated property value.
To assume your mortgage, the buyer will have to bring $75,000.00 in cash. The transaction will not go through if the buyer does not have that amount.
Your lender might as well allow them to get a second mortgage loan to help with that required down payment.
If the buyer ends up getting a second mortgage to help with the payments of the upfront money, the buyer will be exposed to high default risk, which will still affect you.
Note that you will only be off the hook for the mortgage obligation after the new buyer has made payments as required consecutively for 12 months.
There is an inherent risk in managing two mortgage payments.
Also, a second mortgage loan comes with a high rate, which may end up wiping off the interest rate benefits of your low mortgage rate.
The buyer may end up paying a higher default insurance premium than if they had applied for a mortgage directly with a lender.
Default insurance rates are based on your loan-to-value ratio, which is based on the amount of down payment you made towards purchasing your home.
Continuing with the example above, for your down payment of $25,000.00 for a $500,000.00 house, your default insurance premium will be $19,000.00 (a 4.00% premium rate).
For a similar home priced at $500,000.00 but with the required $80,000 down payment, your default insurance premium will be $11.760.00 (at a 2.80% premium rate).
In conclusion, an assumable mortgage is beneficial when the interest rate is considerably lower than you can get elsewhere.
Still, the down payments may negate the benefits.
So, you need to do the math to see if your financial circumstance and needs allow for it.
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