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Couple involved in a real estate transactionAssuming a mortgage is the act of taking over someone else’s mortgage debt along with his home. The process goes something like this. The buyer makes a price offer. The seller accepts that offer. But instead of paying the offer price in cash or by mortgage finance, the buyer pays only the seller’s equity and takes over liability for paying off the seller’s mortgage loan. The seller’s equity is the difference between the offer price and the amount left to pay on the seller’s mortgage.

For a buyer, assuming a mortgage has certain advantages. The buyer effectively becomes the borrower for the purpose of the mortgage loan. He inherits the seller’s repayment term, interest rate and mortgage conditions in full. If the note rate is lower than the prevailing market rate, the buyer gets a cheap loan. What’s more, he doesn’t have to pay points,appraisal fees or any other closing costs.  A seller who can advertise a home with these benefits can generate greater interest from buyers.  In theory, mortgage assumption is a win-win for both parties.

As with most things real estate, mortgage assumption doesn’t work like it should on paper. Today, very few sellers can transfer their mortgages. Here’s why.

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The “Non Assumable” Clause

A mortgage is inherently assumable unless the loan documents specify that it isn’t. Today, almost all conventional mortgages block mortgage assumption. The reason is simple. If a mortgage is assumable, a creditworthy borrower could transfer his mortgage to a less-than-stellar buyer. The risk of default shoots up, and the lender could lose money on the loan.

To protect their interests, lenders insert a “non assumable” clause into their loan documents. If your mortgage contains such a clause, you cannot transfer your mortgage to a buyer without the lender’s consent.

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The “Due on Sale” Clause

A mortgage that does not contain a “non assumable” clause may still block mortgage assumption through the back door. A “due on sale” clause makes the entire mortgage amount fall due as soon as the borrower transfers her property to someone else. If you transfer the loan and the lender calls in the debt, you must pay up or face serious legal and financial consequences.

Due on sale clauses became popular in the 1970s when interest rates spiked, causing homeowners to assume existing loans rather than borrowing new money from lenders at peak rates. Today, almost all mortgages contain a due on sale clause, including government-backed loans from the FHA and VA.

Due on sale clauses are complex beasts. They are complex because they are discretionary: the lender has the option of calling due the loan but it does not have to force early repayment.  Some sellers and buyers run the gauntlet. They decide that the rewards of assuming a mortgage — lower repayments and zero closing costs — are greater than the risk of the lender calling due the loan. In an economy characterized by stable interest rates, this is a fair argument. Banks are unlikely to call due a performing loan if the note rate is within a few points of the market rate. But if interest rates rise dramatically, lenders have greater incentive to enforce a due on sale clause.

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Assuming a Mortgage With the Lender’s Consent

Sellers can always seek the lender’s permission to transfer their mortgage to a buyer. Many lenders will at least consider the request; several will give you a mortgage assumption package that spells out the hurdles you must jump to gain the lender’s permission. Generally speaking, the buyer will have to qualify for the loan. The lender will analyze the buyer’s credit report, debt load, salary and expenses, and will call for her tax returns, employment references and other paperwork before deciding whether the buyer can make the monthly payments. Buyers assuming a FHA loan may find the qualification process easier than those assuming a conventional loan, as FHA underwriting criteria are typically more lenient. However, the decision ultimately rests with the lender.

If you are contemplating as mortgage assumption, the only safe way to proceed is with the lender’s consent. Concealing a mortgage transfer in violation of a due on sale clause might open you up to civil penalties. More immediately, the original borrower remains liable for the loan repayments unless the lender specifically releases him from the loan. Without a legal release, the seller could be called upon to make good the buyer’s default, and late payments and foreclosures will appear as blemishes on the seller’s credit report.

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