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When You Can And Cannot Assume A Mortgage
If a property owner has a house valued at $100,000 consisting of $60,000 outstanding mortgage and $40,000 equity, the owner has to pay off the $60,000 mortgage lien with the sales proceeds upon sale of the property.
However, the situation change if a buyer comes along presenting an owner financing deal that is too good to refuse.
Owner financing has various advantages for both parties and a buyer assuming the existing mortgage of the owner’s house, a deal can be quickly struck and closed.
The basic concept of assuming a mortgage is to take over the loan of an existing borrower and become the new borrower who is obligated to repay it.
When people, both buyers and sellers, learn about assumable mortgages, they often ask whether they are even allowed to do that legally.
The question in fact, should be turned around. And the question asked should rather be whether they are not allowed to do that.
This is because all mortgages are assumable. Just that many lenders put a due on sale or acceleration clause in the contract upon closing which enables them to recall a loan should certain events occur.
This means that lenders have to explicitly put it into the legal loan agreement. The absence of such clauses in a security instrument (mortgage) means that the mortgage is assumable.
Such a clause allows a lender to legally call back the loan should the ownership of the property is transferred.
So the next time someone asks you whether a mortgage is assumable, the questions you should ask is whether there is anything stating it’s not.
As you can see above, in the absence of a due on sale clause, a mortgage is freely assumable.
However, sometimes lender are perfectly fine with their loans being assumed even though they have such clauses in the contract. But they need to qualify the new borrower first.
This is first because of the simple logic that they would want a borrower who has a stake in the property. This makes the new owner the ideal candidate instead of the previous owner.
Secondly, they need to be sure that the new owner is an individual with a sound financial standing and who can realistically afford the loan repayments.
The last thing they’d want is a new owner who will default within the first few months.
So the new owner might be required to go through a credit assessment as if applying for a new loan. This might be a simplified screening or a fully comprehensive loan assessment process.
You might ask why then would a buyer want to assume a mortgage when he/she has to be dragged through the mud that is credit assessment anyway?
One reason being to save on the various costs of loans.
Another being that the existing loan will have already been amortized for a few years.
As in typical mortgages, they usually have a reducing rate of interest most of the time. Such interest calculations result in the borrower having his a high portion of installments paid towards the interest instead of the principal.
By taking over the credit facility some time after it’s commencement, the new borrower will effectively have higher portions of payments more towards the principal loan balance.
The result is paying lesser interest over the long term.
As one can observe, assumable mortgages come with various pros and cons.
Subject to existing loan
Another variance of such practices is to buy a property subject to the existing loan.
This occurs when a buyer buys a property without assuming the mortgage, and that no arrangement has been made to fully redeem the existing loan.
This is the playground of flippers and very experienced real estate investors. So please don’t jump in if you are a rookie in property investing.
People usually get into this sandwich situation because of a full intention to buy and sell a property quickly. So fast that he would be long gone by the time the lender has realized the change in ownership.
They wouldn’t even have time to write the word accelerate on any recall letter.
The risk the investor takes on is the failure to complete a quick transaction.
If the investor plans to keep hold of the property for a long time, then he must be ready that the lender would inevitably take action to accelerate the loan.
When this happens, he has to either repay the loan, refinance it, or assume it. Otherwise foreclosure proceedings might be initiated by the bank.
From a legal standpoint, the new owner would still not be liable to the outstanding balance amount owed to the lender as he had not signed the original note.
However, depending on what was agreed upon and signed with the previous owner, the previous owner could have a valid case to take the new owner to court for defaulting on the loan.