Mortgage assumption occurs when a buyer agrees to accept existing debt on a property along with the purchase of that property. This kind of agreement almost always requires the consent of the bank or other lender who holds that loan. Without a mortgage assumption clause, the debt automatically remains with the owner of the property prior to the sale.
A mortgage assumption clause is necessary if the buyer will assume an existing mortgage along with the property to be sold. This clause transfers the responsibility of repaying the mortgage from the seller to the buyer. With a mortgage assumption clause, the buyer pays only the difference in home equity, if any, to the seller. The remainder of home equity remains tied up in the assumed mortgage until it is repaid.
A common use of a mortgage assumption is when a prospective buyer would prefer to keep the existing mortgage on a property rather than apply for a new mortgage. This practice cuts down on mortgage fees related to opening and closing a mortgage and early mortgage repayment, although settlement costs still need to be paid.
Mortgage assumption clauses are more common when the existing mortgage rate is below the current market rate. If the savings due to the lower rate are greater than settlement costs, it may be worthwhile to consider a mortgage assumption clause.
While a mortgage assumption may seal the deal, it can also increase the risk to the seller. Although a mortgage assumption clause transfers liability to the buyer, the seller also remains liable unless and until the lender releases him from liability. If the lender does not release him and the buyer is unable to meet the terms of the mortgage and defaults, the seller must pay off the mortgage himself. Because the buyer may not have qualified for the assumed mortgage in the usual way, the seller may end up worse off than if he had foreclosed.
For this reason, a mortgage assumption clause should never be included in a sales contract unless the lender has been notified of the sale and explicitly agrees to release the seller from all liability for the mortgage. Most lenders are reluctant to do this.
One case where mortgage assumption is viewed more favorably by the lender is when a house is transferred between relatives, especially from parent to child. Other similar situations may occur in case of title transfer after divorce or death. However, the original owner cannot previously have been in default on that mortgage. A transfer after default may be viewed by the lender as fraudulent.
A mortgage can be transferred without the lender’s consent, although this is obviously even more risky to the seller. This is sometimes referred to as a sale “subject to” the existing mortgage. In this case, the seller always retains final liability for the existing mortgage. The lender also retains all rights to call in the mortgage under the due-on-sale provision in most mortgages.
Lenders usually prefer to vet the buyer independently, close the old mortgage, and issue a new mortgage geared to the buyer, rather than just transfer the old mortgage. In most cases, an assumed mortgage must be taken on at current market prices, regardless of the original rate.
Federal Housing Administration mortgages and Department of Veterans Affairs mortgages do not contain due-on-sale provisions. These mortgages are fully assumable by the seller, but the seller must be approved by the issuing agency.