Homebuyers

An FHA Assumable Loan: What You Need to Know

FHA Assumable Mortgages

When trying to finance a new home, the traditional path of choosing a lender and applying for a mortgage is one that many homebuyers follow. However, another valuable option currently being offered to people looking to buy property is assuming the existing mortgage. Assumable loans allow potential homeowners to take over the previous homeowner's mortgage directly when buying a house, benefiting both the buyer and the seller.

The highly popular FHA loans, under the governance of the Federal Housing Administration, fall under this category, too. However, specific criteria must be met to successfully apply for an FHA assumable loan.

Find out information on what these criteria are, how exactly an FHA assumable loan works, and the many potential benefits that come along with one below.

Are FHA Loans Assumable?

Yes, FHA loans are assumable. Every mortgage issued by the FHA is assumable, allowing first-time homebuyers with credit limitations another avenue to homeownership.

Unlike other FHA loan transactions, an FHA loan assumption follows a different process. Firstly, the lender must ensure the person assuming the loan possesses good credit through the underwriting process. As with other loans, lenders will review your debt-to-income ratio as well. They want to make sure it is possible for and likely the borrower will make their mortgage payments. This will be followed by other rules which may apply depending on the time the original mortgage was created.

Further, any FHA loans issued before December 1, 1986, are ‘freely assumable’. This means that there are no restrictions on the release of new assumptions, making older homes more appealing to those looking for a new house.

What is an Assumable Mortgage?

The existence of assumable mortgages allows potential homebuyers to directly take over the seller’s existing home loan, bypassing the sometimes long and drawn-out mortgage application process. Such things as the remaining balance, interest rate, and repayment method stay the same, with only the responsibility of paying the debt changing from the seller to the buyer.

This mortgage type is attractive to buyers when interest rates rise, as their new assumed mortgage — which existed before the interest rise — has a lower rate. Different loan types can successfully be assumed when all their criteria are met, including USDA, VA loans for veterans, and FHA loans.

How Does an Assumable Mortgage Work?

While an assumable mortgage allows a buyer to acquire the remaining balance of the principal loan, it does not factor in equity. If a particular home has gained value since the issuing of the original loan, the buyer will need to pay the difference — or home equity — with cash or another loan.

An assumable FHA mortgage works in the same way, but a buyer will need to meet certain criteria before taking over an existing FHA mortgage. Among these criteria, a buyer will need a credit score of at least 580 and a debt-to-income ratio of 43% or less.

Buyers should also be aware that the lenders of the original FHA loan can change the terms of the agreement if they consider it necessary. They may do this based on new liabilities like the personal credit risk of the buyer as well as current market conditions.

Can Family Members Assume FHA Loans?

Yes, family members can assume an FHA loan if the possessor chooses to transfer it to a relative and the Department of Housing and Urban Development (HUD) has given permission.

If a spouse wishes to assume their significant other’s FHA loan, they will need to prove their creditworthiness to the FHA while meeting their standards. The same is true for a child wishing to take on their parent’s FHA loan.

Additionally, extra steps will need to be taken for related persons, not on the title to gain ownership of the property.

Benefits of an FHA Assumable Loan

Assuming an FHA loan can be a highly beneficial prospect that can help a buyer purchase their new home either as a new place of residence or as part of their investing goals. Four excellent benefits of assuming an FHA loan are:

• Likely Lower Interest Rate: If interest rates have increased since the original FHA loan was first issued, assuming a loan can be a big advantage to a homebuyer. Assuming the loan could allow them to avoid paying these high rates or even higher rates in the future.
• Lower Closing Costs: When a buyer takes on an FHA assumable mortgage, they can save a large quantity of money on closing costs. Some closing costs will still have to be paid, like the mortgage lender’s assumption fee, but the total sum of the closing costs will most likely be lower than with a new mortgage.
• Chance to Remove MIP: If the original FHA loan was issued before July 3rd, 2013, the mortgage insurance premium (MIP) has a chance to be removed after the remaining loan balance drops to 78% of the original purchase price.
• Possibly Optional Appraisal: After assuming an FHA mortgage, the original lender of the FHA loan will usually not require a new appraisal.

Check out the current mortgage rates here.

When is an Assumable FHA Loan Bad for the Buyer?

If a potential homebuyer is looking to purchase a new house, they will need to be aware of the home’s value. In some cases where there has been an increase in the home’s value or if the seller has paid a large amount of the mortgage balance, the buyer will be required to pay a larger down payment.

If the down payment that a buyer must pay to assume an FHA loan meets or exceeds 20%, they could instead qualify for a Conventional loan that does not have private mortgage insurance (PMI). 

Is an FHA Assumable Loan Bad for the Seller?

There are pros and cons to all loan options and mortgage assumption should always be considered holistically.

An FHA assumable mortgage may be bad for a seller in situations where the buyer defaults on the loan. If this occurs, the seller may be liable to the lender for outstanding debt that has not been recovered. To avoid this situation, sellers should discuss with their lender to verify this before continuing with the FHA loan assumption process.

Another way an FHA assumable loan can be bad for the seller is if added repairs need to be made to the home. For instance, if the seller’s home is not up to the FHA’s livability standards once an appraisal has been conducted. If the appraiser does not find that the home meets the FHA’s standards, it could potentially delay the close of escrow and result in the loss of the sale.

FHA Assumable Loan Considerations

When taking out an FHA loan, up to 96.5% of the home’s value is available to the borrower and can only be assumed by applicants with a credit score of at least 580, among other factors.

The approval process when attempting to assume an FHA mortgage originating on or after December 15th, 1989, is the same as if the buyer were applying for a new FHA loan. Applicants should study the requirements for a typical FHA loan and gather the documents needed to make the assumption process go smoothly.

Each lender or banker will also have their own set of applicable eligibility and qualification requirements.

FHA Assumable Loan Misconceptions

The idea that an FHA assumable mortgage does not remove original owners from loan responsibility is not true (under certain circumstances). If the original borrower signs the needed loan transfer documentation, then they will not be liable for the remaining balance.

An example of this would be if the new borrower loses the ability to make the monthly payments and defaults on repaying their assumed loan. Ordinarily, and without the proper paperwork, the seller would be liable. With the paperwork completed, though, this situation will not arise.

FHA Loan Assumption Closing Costs

Typically, FHA loan assumption closing costs are between 2% and 6% of the home’s sale price. This is usually much less than the closing costs associated with Conventional loans (which can total as much as 20%).

The payments and fees associated with an assumable FHA loan also include the upfront mortgage insurance premium, as well as all prepaid items such as homeowners’ insurance, property taxes, service fees, and the initial escrow deposit.

In addition, buyers should keep in mind that related closing costs vary by state and are much higher in states with high tax rates. Speak to a loan officer at New American Funding before the FHA loan assumption to have them prepare a loan estimate so you can understand exactly what prices to expect from closing costs.

FHA loans are timely right now, so thinking about assuming one can be highly beneficial. However, both buyers and sellers should be aware of the differences between applying for an FHA loan and the process around assuming one, so an in-depth talk with a mortgage lender for both sides may be a wise idea.

If you are interested in applying for an FHA loan instead of assuming one, or in any of our other programs and listed products, our loan officers at New American Funding will be happy to help you find the right loan to fit your needs.

You can also use our mortgage calculator to estimate your loan costs and payments.