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Assuming a mortgage means that the buyer of a home is able to take over the seller’s existing mortgage. When mortgage assumption is possible, it may help a buyer score a lower interest rate and save money in other ways as well. In times when interest rates are headed upward, an assumable mortgage can be quite a windfall.

But, reality-check time: Mortgages are only assumable in certain situations, and there are pros and cons to consider. If you’re home shopping and want to consider this option, read on to learn more, including:

•   What is an assumable mortgage?

•   How do I know if a mortgage is assumable?

•   What are the benefits of an assumable home loan?

•   What are the downsides of an assumable mortgage?

What Is an Assumable Mortgage?

The meaning of an assumable mortgage is that the buyer, when purchasing a home, takes over the existing mortgage held by the seller. This means the buyer assumes responsibility for the loan’s outstanding balance, its interest rate, and making payments for the entire loan term.

This can be an appealing option if, say, the seller’s mortgage was taken out with a considerably lower interest rate than is currently available. In this scenario, the buyer could stand to save thousands over the life of the mortgage loan.

However, a buyer may also need to finance the amount of equity the seller has in the home.

It’s important to note that not all mortgages are assumable. For those that are, it’s recommended that all parties know in advance what obligations they have when they agree to a mortgage assumption, just as with any other financial agreement.

What Types of Loans Are Assumable?

Typically, home loans that operate outside the federal government’s mortgage loan environment, such as conventional 30-year mortgages issued by private lenders, are not assumable. (How do you know if a conventional mortgage is assumable? It will likely be an adjustable-rate loan, and the seller will have to check with their lender to be sure.)

Certain kinds of mortgages that are insured by the government and issued by private lenders are, however, assumable. A seller usually must obtain lender approval for the assumption, or in the case of USDA loans, agency approval. And the buyer must qualify. These loans include:

•   FHA loans: The Federal Housing Administration (FHA) insures these mortgages, which are popular with first-time homebuyers. With a minimum 3.5% down payment for borrowers with a credit score of 580 or higher, FHA mortgages are assumable.

•   VA loans: Home loans guaranteed by the Department of Veterans Affairs (VA) are also assumable, and — perhaps surprisingly — the buyer does not have to be a veteran or in the military. Note: The seller of these loans may remain responsible for the mortgage if the buyer defaults.

•   USDA loans: Loans guaranteed by the Department of Agriculture (USDA) are assumable only if the current owner is up to date on payments.

One last note about the options above: While assumable mortgages can be part of a wrap-around mortgage, they are not one and the same.

When a mortgage is assumed, the buyer pays the lender every month. With a wrap-around mortgage, which is a kind of owner-financing, the buyer pays the seller.

How to Get an Assumable Mortgage Loan

Here are some points to consider if you are contemplating assuming a mortgage:

•   First, confirm that the loan is assumable. For most conventional mortgages, assumption is not an option.

•   If assumption is possible, the homebuyer must apply for the assumable mortgage and be vetted for creditworthiness and the ability to meet all the contractual requirements. It’s vital that the buyer show that they have the financial assets needed to qualify for the loan.

•   Recognize that the buyer will need to make up any difference between the amount owed and the home’s current value. This means that if the seller of a $300,000 home has a $100,000 mortgage that’s assumable, the buyer would need to be able to put down $200,000 to assume that loan. Obviously, this scenario could present a significant financial hurdle for many prospective homebuyers.

•   If the mortgage lender or agency signs off on the deal, the property title goes to the homebuyer, who starts making monthly mortgage payments to the lender.

•   If the lender denies the application, the home seller must move on, and the buyer would likely resume shopping elsewhere.

Recommended: How to Buy a Multi-Family Property

Why Do Assumable Mortgages Exist?

Actually landing an assumable debt can be beneficial for both a buyer and seller, but the mortgage lending industry may not make it easy to cut a deal. Why? Because as history attests, mortgage lenders may lose money on assumable mortgages.

In the late 1970s and early 1980s, when interest rates were at the highest levels in modern history, assumable mortgage deals were attractive to buyers who could take over a seller’s mortgage at the original loan interest rate. In many cases, this would yield a bargain vs. the then-current rate for a new mortgage. (How high did rates go? In October 1981, 30-year fixed-rate mortgages hit an eye-watering peak of 18.45%.)

Mortgage companies, however, could see that they would lose money if home buyers chose a lower-rate assumable loan over a higher-rate new mortgage loan. That’s one reason mortgage companies began inserting “due on sale” clauses, which mandated full repayment of the loan for most home transactions.

As the FHA and VA began issuing more mortgage loans to homebuyers, they offered more relaxed rules allowing assumption transactions. Mortgages could transfer to the homebuyer as long as they demonstrated the ability to repay the remaining home loan balance, usually after a thorough credit check.

How Do Assumable Mortgages Work?

With an assumable mortgage, the buyer will become the holder of the mortgage originally taken out by the seller. The buyer, as mentioned above, may have to clear certain qualification hurdles to do so.

It’s also important to note that, as briefly mentioned above, the homebuyer must make up any difference between the amount owed on the mortgage and the property’s current value. That could mean the buyer pays cash to make up the difference or takes out a second mortgage.

An example: Say a house is valued at $350,000, and the home seller has a $225,000 balance on the home’s original mortgage. Under the terms of most assumable mortgage loans, the homebuyer would need to deliver $125,000 at closing to cover the difference between the original mortgage and the current estimated value of the home, usually determined by an appraisal.

Another important aspect of how assumable mortgage loans work are the two models possible: a simple mortgage assumption or a novation-based mortgage assumption.

Simple Assumption

In a typical simple mortgage assumption, the buyer and seller agree to engage in a private transaction.

•   This means that the mortgage lender is not necessarily aware of the transfer of the mortgage and therefore the new buyer does not go through the underwriting process with the lender.

•   The home seller usually just transfers the title of the property to the buyer after the buyer agrees to take over the remaining mortgage payments.

•   If the buyer misses monthly payments or defaults on the original mortgage loan, the lender could hold both parties responsible for the debt, and the credit scores of both buyer and seller could be significantly damaged if the debt isn’t repaid. In this scenario, an assumable mortgage home for sale could wind up being problematic for both parties.

Novation-Based Assumption

Unlike a simple mortgage assumption, where mortgage underwriting usually isn’t directly involved, an assumption with novation means the lender is involved.

•   The lender vets the buyer and agrees to the loan transfer.

•   This means the buyer agrees to assume total responsibility for the existing mortgage debt and remaining payments.

•   Under those terms, the original mortgage lender releases the home seller from liability for the remaining mortgage loan debt. The documentation, such as a deed of trust (if used), will be in the buyer’s name alone.

Pros and Cons of Assumable Mortgages

Assumable mortgage loans have upsides and downsides.

Upsides of an Assumable Mortgage

First, consider these pluses:

•   A lower rate may be possible. The buyer may save significant money on the loan if the original mortgage’s interest rate is lower than current rates.

•   Closing costs are curbed. The buyer might also benefit because closing costs are minimized in private home sale transactions between a buyer and a seller.

•   No appraisal is needed. With no need to get a new mortgage on the property, a home appraisal isn’t required for a mortgage assumption, which can save time and money. The buyer could request an appraisal as part of the general home purchase agreement, however.

Downsides of an Assumable Mortgage

Now, the minuses:

•   Upfront cash may be required. To meet the terms of an assumable mortgage, the buyer may need to have a substantial amount of upfront cash or take out a second mortgage to close the deal. This usually occurs when the property’s value is greater than the mortgage balance. The seller has perhaps built up considerable equity over the years.

•   Second mortgages can be problematic. Second mortgages aren’t always easy to obtain, as mortgage lenders may be reluctant to issue a second home loan when the original mortgage still has a balance due. And a second mortgage probably carries closing costs, meaning the seller needs to shell out more cash.

•   The property may be in distress. In some cases, the home seller may be eager to get out of a home that is proving to be too expensive for their budget. Simply put, they might be behind on payments. In that event, the mortgage lender may require the mortgage to be made current (meaning getting up to date on payments) before it will approve an assumable mortgage.

•   FHA loans carry an add-on. If the home seller put down less than 10% of the home’s cost when getting an FHA loan, there will be a mortgage insurance premium for the entire loan term. This would add to the buyer’s monthly costs.

Here’s how this intel stacks up in chart form:

Examples of Assumable Mortgages

If you’re hoping to find an assumable mortgage, it will most likely be a government-insured or -issued loan, as mentioned above; perhaps one offered as a first-time homebuyer program. Here’s a bit more about these mortgages and how a loan assumption would work:

•   Federal Housing Authority (FHA) loans: These government loans, which are insured by the FHA, may be assumable. Both parties involved in a mortgage assumption, however, must qualify in certain ways. For instance, the seller must have been living in the home as a primary residence for a period of time, and the buyer needs to be approved via the usual FHA loan application process.

•   Veterans Affairs (VA) loans: If a seller has a loan backed by the VA, it may indeed be assumable. A buyer who wants to take over the loan can apply for a VA loan assumption and doesn’t need to be a current or former member of the military service.

•   U.S. Department of Agriculture (USDA) loans: To assume a USDA loan on a rural property, a buyer will have to show an adequate income and credit to be approved by the USDA.

Recommended: Buying a Home with a Non-Spouse

Who Are Assumable Mortgages For?

Assuming a mortgage can be a good option for those who are property shopping in a time of rising interest rates and would like to take over the seller’s lower-rate loan. This can help save money, and it can also spare the buyer some of the time, energy, and money needed to apply for a new loan.

In addition, an assumable mortgage may work best for buyers with access to cash, as they will probably need to cover the difference between the mortgage amount and the value of the home they are buying.

Who Are Assumable Mortgages Not For?

Those purchasing a home that currently has a conventional mortgage will most likely not be able to take over that loan.

Additionally, if a mortgage is assumable, it’s important to recognize this scenario: If there’s a considerable gap between the mortgage amount and the property’s value, the buyer needs to bridge that. That means either ponying up a chunk of cash or finding a second mortgage, which may not be financially feasible for some prospective homebuyers.

The Takeaway

Assumable home loans are generally difficult to find and to close, and may require the buyer to take on the onerous task of qualifying for a second mortgage. But if the buyer finds that assuming the mortgage will save money over getting a new mortgage (primarily through a lower rate), an assumable mortgage could be a good way to go.

Hunting for a mortgage? SoFi offers home mortgage loans with as little as 3% down for first-time homebuyers, and getting prequalified is quick and easy.

FAQ

Is it a good idea to assume a mortgage?

Assuming a mortgage can have benefits. If you find an assumable mortgage home for sale, you might be able to take over the seller’s mortgage at a lower rate than what’s currently offered by lenders, thereby saving you money over the life of the loan. Closing costs and schedules might also be leaner. However, mortgage assumption is not always possible, and if it is, you may have to make up the difference between the mortgage amount and the home’s current value.

What is required to assume a mortgage?

To assume a mortgage, the seller must have a loan that allows for assumption. These are usually government-insured or -issued mortgage loans. In addition, you may have to submit credentials to the lender and be approved. You may also have to pay the difference between the mortgage amount and the property’s market value.

How much does it cost to assume a mortgage?

Typically, when you assume a mortgage, you may pay some closing costs, but these could be lower than on a new loan. In addition, there may be a one-time funding fee; for instance, on a VA loan, this amounts to 0.5% of the existing mortgage balance. Last but not least: The buyer is usually liable to pay the difference between the remaining balance on the mortgage and the current value of the home.

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As is the case with any investment, you can lose money in an index fund. Still, index funds allow investors to track the market in a low-cost, consistent way, according to most analysts and advisors. That’s because an index fund provides exposure to a diverse selection of publicly traded securities that are intended to perform identically to a market index.

However, index funds don’t always perform in an exact one-to-one ratio, as we will see. But in general, most high-quality index funds perform in close lockstep with their underlying indexes.

How Can You Lose Money in an Index Fund?

All investments carry risk. An index fund, like anything else, can potentially lose value over time.

That being said, most mainstream index funds are generally considered a conservative way to invest in equities (although there are lesser-known index funds that are thought to carry greater risk). This is largely due to the fact that index funds are greatly diversified, distributing risk throughout many securities. Risk is also lowered by reducing an individual’s responsibility in managing the funds — investors can simply buy and hold for years, or even decades.

As you weigh the risks, also keep in mind that most financial experts agree that the biggest risk is not investing at all. While saving money is important, inflation steadily eats away at savings over time.

How Does an Index Fund Work?

Index funds are part of a growing trend of what’s referred to as “passive investments.” Similar to an exchange-traded fund (ETF), an index fund is composed of many different assets packaged into a single security that investors can trade like a regular stock.

When you buy shares of an index fund, many people think that you are almost buying a tiny piece of a share of every company in that index all at once. An S&P 500 index fund, for example, gives investors exposure to most 500 companies in the S&P 500, or so the story goes. And some index funds do work this way.

But in reality, things are not always so straightforward. The goal of an index fund is to track the performance of a stock market index, and the fund can invest in any number of assets to achieve this end. That often does include a substantial amount of holdings of the stocks contained in a specific index, but there can be other assets included as well.

Some funds might not actually hold any of the assets that are present in the index they are supposed to be tracking. Instead, they might invest only in derivatives, like options and futures, that are intended to perform similarly to the index.

Some funds also provide leverage, meaning they are designed to provide returns or losses greater than what their respective index provides. If a fund has 3x leverage, for example, then it might produce a return or loss three times as high as what its index does. Leveraged bets of any kind are generally considered to be riskier and more speculative.

How Likely Are Index Funds to Go to Zero?

Index funds are generally not as volatile as individual stocks because of their diversification. But of course, if the underlying index is volatile, then the index fund will be, too, assuming it tracks the index’s performance well.

Investors who stick to well-established index funds that own real assets probably don’t have too much to worry about — but they aren’t 100% free of risk either.

Markets don’t go up or down in a straight line, so over the short term, funds will fluctuate. But index funds can provide a good option to gain exposure to broad swaths of the market without having to select individual stocks or manage a portfolio actively.

Although any index fund comes with risk of loss, like all investments, some funds may have a real possibility of losing a significant portion of investment capital. Leveraged funds and funds that invest in derivative products have a higher-than-average chance to produce suboptimal returns.

Over long periods of time, though, most indexes have seen large returns, as the large companies that are included in most indexes continue growing.

What Are the Benefits of Investing in Index Funds?

The benefits of index funds involve everything described so far. Low risk and high diversification provide an excellent way to grow wealth steadily over time. For this reason, index funds can be a reasonable option for most long-term portfolios.

For the most part, major index funds with an established track record don’t require much active management. That’s why they fall under the umbrella term “passive investments.” This is another reason why some investors like index funds: They don’t have to keep track of a bunch of different securities, their performance, or their latest news releases and company fundamentals.

Some Common Misconceptions About Index Funds

Not all index funds are created equal, and not all of them work in a simple, straightforward manner. While the general concept may be simple enough, in practice things don’t always work out the same way.

Here are a few notes about some of the most common misconceptions about index funds.

Index Funds Always Perform the Same

Sometimes, some index funds might provide returns less than the actual index they track. This can happen for a number of reasons. A high expense ratio, for example, might mean that there are hidden fees associated with owning the fund, making it more expensive.

To this end, it can be important for investors to make sure their funds won’t underperform. Index funds are generally a good way to minimize bad decisions, but only if someone chooses a fund that has broad exposure and low fees.

All Index Funds Are Low Risk

As mentioned, index funds tend to be on the lower end of the risk spectrum. But not all index funds are created the same. For investors looking for minimal risk, it might be wise to seek out a fund that directly owns shares of stocks, offers the most diversification possible, and has a long-standing track record of performance that mimics its underlying index.

Index Funds Work Well As Short-Term Investments

In general, some advisors suggest that index funds ought to be held for at least five years, if not 10 or more.

Funds of this type don’t make for good short-term investments because they usually don’t move a lot over short time periods, and the fees or commissions involved tend to eat into the meager profits investors might gain.

There are certain leveraged funds and ETFs that are better suited to short-term trading, but we won’t get into those here.

Try Investing With SoFi Invest

Can you lose money in an index fund? Of course you can. But index funds still tend to be an appealing choice for investors due to their built-in diversification and comparatively low risk. Just make sure to note that not all index funds always perform the same, and that now every index fund out there is low-risk.

If you’re beginning your portfolio-building journey you might consider getting started with SoFi Invest®. The platform offers educational content as well as access to financial planners. Plus, the Active Investing platform lets investors choose from an array of stocks, ETFs, or fractional shares.

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