Perspective | These cheap loans are becoming a hit with home buyers. But there are catches. (2024)

The number of sales closed with this financing, although still small overall, has skyrocketed. In 2023, 3,825 FHA loans were assumed, compared with 2,221 in 2022. In just the first five months of 2024, an additional 3,477 FHA assumable loans were recorded, putting borrowers on track to more than double last year’s total.

VA loan assumptions recorded an even steeper spike, from 308 in 2022 to 2,244 in 2023. This category looks set to more than double that total this year, with 1,457 assumptions recorded in the first three months of 2024.

What are assumable mortgages?

Assumable mortgages are government-backed loans that the seller can transfer to the new owner when a property is sold.

That means the new owner is on the hook for the remaining mortgage payments, the loan balance, the payment schedule, the interest rate and the escrow account under the same conditions, said Kelly Zitlow, executive vice president of sales and marketing and a senior mortgage adviser at Cornerstone Home Lending.

Chris Birk, vice president of mortgage insight at Veterans United Home Loans in Columbia, Mo., said he hears that more “home sellers and buyers are talking about assumable loans” and that roughly 4 in 5 active VA mortgages have an interest rate below 5 percent.

That’s still a tiny share of overall home sales. In 2023, more than 4 million existing homes were sold nationwide, according to the National Association of Realtors. But the uptick in assumable mortgages shows increasing interest among home buyers looking for deals.

How do assumable mortgages work?

Assuming a mortgage requires steps similar to the ones for a traditional mortgage. The buyer needs to meet the credit, debt and income requirements set by VA or the FHA and by the lender or servicer that holds the loan.

But there’s one key difference: The loan can be financed only through the seller’s existing lender, with approval from the lender, Zitlow said.

In other words, you can’t shop around when you’re assuming someone else’s mortgage.

In addition, the buyer needs to make up the difference between the sales price and the loan balance. Since buyers can’t increase the balance on an assumable loan, they typically will need to pay the rest of the purchase price in cash. However, some buyers may be able to secure a second loan, Birk noted.

For example, if you purchase a home for $500,000 and the remaining balance on the seller’s assumable loan is $400,000, you’ll need to pay $100,000 in cash unless you can qualify for a second loan.

Who can qualify for an assumable mortgage?

The first question to ask is whether the seller has an FHA or VA loan. These actually make up a significant share of the market: About 13 percent of all mortgages are FHA loans, while about 11 percent are VA loans. These loans are insured by the federal government, which means that if the borrower defaults, the lender will be reimbursed. Lenders that issue these loans may be a little more lenient in their requirements as a result of this backing.

The second question is whether the buyer can meet the specific requirements to take over the loan.

In the case of FHA loans, the property must be the seller’s primary residence and the buyer must meet the qualifications set by the FHA and the lender, Zitlow noted.

For VA loans, a regional VA loan office has to approve the transaction, but the borrower doesn’t have to be a veteran, she added.

In addition, the seller has to sign off on the buyer assuming the loan and provide authorization to the lender. Once the loan is approved and the sale goes through closing, the loan servicer replaces the original borrower with the new owner on the loan documents, Zitlow said.

What are the pros and cons of assumable mortgages?

The main advantage of an assumable mortgage is that it can lock in a cheaper interest rate — meaning lower monthly payments and less interest over the life of the loan. In addition, the settlement may go more quickly than a traditional loan closing (sometimes with no appraisal required), and closing costs are often lower, Zitlow said. The one big hurdle in many cases, as noted above, is that the person assuming the loan generally needs a lot of cash on hand to pay for the property — often more than a typical down payment.

“However, some lenders … can help a potential buyer cover this gap by offering a second loan,” she said.

Depending on the credit qualifications of the buyer, a lender might allow the combined balance of the assumable loan and the second loan to go up to 80 percent or 85 percent of the home value, which would need a down payment of 15 percent or 20 percent, she added.

For sellers who are military veterans, a potential drawback with assumable loans is that they could lose their VA loan benefit, Birk said.

Typically, when a home is sold, the VA loan is paid in full, and the veteran can still get the VA discount on interest rates. But when a loan is assumed, it continues to be serviced by someone else who is making the payments — so whatever portion of the veteran’s benefit that was used to buy that house stays tied up in the property until the loan is paid off, he noted.

“In some cases, veterans would have diminished VA loan entitlement for their next purchase, which would likely mean they would have to make a down payment,” he added. “In other cases, veterans wouldn’t have enough of their benefit remaining to get another VA loan at all.”

To avoid this, a veteran could choose to sell only to other veterans, which would essentially substitute the buyer’s VA loan benefit for the seller’s, Birk said. That way, the seller could regain full access to the VA loan benefit.