A mortgage assumption – what’s that, you ask? You may have heard of a VA mortgage assumption but my guess is this is an unfamiliar term for most readers. An assumption is generally defined as a purchase transaction where the purchaser takes over the liability of an existing mortgage from the seller.
It can be a tool used to get you out of a difficult position and moving on with your life somewhere new. Or, it can be a formula for disaster, ruining your credit and tying up your VA home loan eligibility.
In a typical purchase transaction, the buyer is released of all liability upon sale. At closing, the buyer’s existing mortgage is paid in full and the seller obtains a new mortgage through their lender. The seller can also restore his VA mortgage entitlement upon sale.
This isn’t the case with an assumption. Instead of paying off the loan and closing out the seller’s mortgage, the buyer takes it over (assumes the mortgage) and continues to make the payments. Even though the buyer isn’t obtaining a new mortgage the current mortgage servicer has to approve the assumption. The important take away here is that it’s still the same mortgage and this results in the buyer being on the hook for the loan if payments aren’t made, unless a release of liability in writing is received from the loan servicer. Additionally, the seller’s VA mortgage entitlement may also remain tied to the mortgage.
Assumptions are beneficial to a buyer if:
- The current mortgage has an interest rate lower than the rates available at the time of sale, the buyer can continue to pay at the lower interest rate.
- The parties can avoid settlement charges.
- The buyer can pay cash for the difference between the agreed sales price and the balance of the current mortgage (instead of taking out a second mortgage at a higher rate).
Can I Use My VA Entitlement After an Assumption?
The short answer is yes, you can use your VA entitlement after an assumption. There are two options in dealing with entitlement on an assumption:
- The seller’s entitlement can be assumed with the mortgage.
- If the buyer also has VA entitlement, he can substitute his entitlement for that of the seller’s.
A substitution of entitlement can free up the seller’s entitlement for use on another home. Otherwise, the seller will have to look into using his/her second tier entitlement or any remaining portions of the initial entitlement. If you sell a home and your entitlement remains tied to the property, you can talk with your VA mortgage specialist to determine what entitlement you have remaining. You will just need a copy of your certificate of eligibility to run the calculations and frequently your VA mortgage specialist can obtain your COE for you.
Is An Assumption Ever A Good Idea?
There is a lot of risk when deciding to do an assumption rather than an outright purchase and sale where the sellers mortgage is paid off and the buyer obtains a new one. In effect you’re entitlement is tied to the buyer for the life of the loan, and their bad decisions or financial hardships can negatively impact your eligibility. If your entitlement remains with the home, and the new buyer loses the home to foreclosure, short sale or bankruptcy, it can greatly impact your eligibility. The VA loan benefit is a guarantee benefit, in that the VA guarantees a portion of your loan in case of foreclosure. When a VA mortgage is foreclosed on, the VA loses money. To reinstate your entitlement after foreclosure, you may have to pay restitution on all or a portion of the losses.
In circumstances where an assumption would be needed resulting from the buyer’s inability to qualify for financing through a mortgage lender there is a significant amount of risk involved. If a lender is unwilling to approve the buyer for a mortgage that means the lender thought the buyer was too much of a risk, for one reason or another. Do you really want your credit and eligibility tied to this person? This is why the VA requires the transaction to be approved through the loan servicer or retroactively.
There are of course other reasons one may agree to an assumption, as we outlined above. If the assumption is only occurring because the rate is lower on the current mortgage than the available rate at the time of sale, you have a little more protection, assuming the buyer could qualify for a mortgage on his own and substitute his eligibility for yours.
So is a mortgage assumption ever a good idea? This is really where you need to weigh your options and the risks involved with a particular buyer. I’d be very selective of whom you consent to assume your mortgage and do plenty of research into all other options as well so that you can make an educated decision regarding whether an assumption is worth pursuing.
If you have any questions, please don’t hesitate to reach out to me at email@example.com.
Photo courtesy Donovan Caruso