Are FHA Loans Assumable?
FHA is an acronym for the Federal Housing Administration. An FHA loan is a mortgage that is issued by an approved FHA lender and insured by the FHA itself. It is designed for low to moderate income borrowers with lower credit scores and a reduced minimum down payment. Which begs the question, “are FHA loans assumable”?
Are FHA Loans Assumable?
According to the Department of Housing and Urban Development (HUD), all FHA-insured loans are assumable if the new borrower can qualify for the loan and the existing loan has no restrictions placed on it.
Right now, you may have questions regarding FHA assumable loans and how to acquire them. This article will outline everything you need to know about FHA assumable loans and how they work.
How does an FHA Assumable Mortgage Work?
An FHA assumable mortgage requires a credit score of at least 600 (as opposed to a conventional loan which must be seven hundred or higher). Mortgage insurance ‘for life’ is mandatory, unless you assume a loan that was created prior to this requirement being implemented. A debt-to-income ratio of 43% (or less) is also mandated. So, for example, if you earn $5000 per month, your mortgage (or debt payment) cannot exceed $2,150.
The concept behind an assumable mortgage is quite simple. Basically, it allows the home buyer to take over the mortgage of the seller, as long as the mortgage lender approves it. For example, if the seller has an assumable mortgage of $100,000 but the house is selling for $150,000, then the buyer will need to come up with an additional $50,000 to purchase the home.
It is important to note, however, that even though the buyer has agreed to assume the seller’s mortgage, the lender is entitled to change the terms of the agreement, if necessary. Reasons for this often include the buyer’s credit risk (which includes the possibility of default on a debt) as well as the current market conditions.
This leads us directly into the next topic, which is whether assuming an FHA loan is actually beneficial to the seller as well as the buyer.
Benefits of an FHA Assumable Loan
The only time that it becomes beneficial for both the buyer and the seller is if the current mortgage rates are higher than the loan that will be assumed.
For example, if the home was financed 10 years ago with an FHA loan at a rate of 5%, but now the rates are up to 7%, then assuming the seller’s FHA loan can be beneficial. In this situation, the buyer has an opportunity to buy a home today with the benefit of having yesterday’s lower rate. This rate benefit means the loan assumption brings additional value.
Another benefit is if the original FHA loan was dated prior to July 3rd, 2013, the mortgage insurance premium may be removed once the loan balance drops to 78% of the original purchase price. We suggest reading our article on FHA mortgage insurance premiums to learn more.
The benefit for the seller is he or she may be able to get full price (or more) for the home due to the lower mortgage rate on their loan.
When is an Assumable FHA Loan Bad for the Buyer?
If the home value has increased and/or the seller has paid down quite a bit of the mortgage balance, then the buyer will need a large down payment.
For example, the home originally sold for $100,000 and the loan amount was $96,500. However, now the selling price for the home is $125,000 and the loan balance is $92,000. In this scenario, the buyer would need to come to closing with a down payment of $33,000 which is 26% of the purchase price.
In this scenario above, it probably would not make sense to assume the FHA loan. You have a down payment of more than 20% which means you could qualify for a conventional mortgage with no PMI.
Is an FHA Assumable Loan Bad for the Seller?
FHA assumable loans often benefit the buyer, but do they also benefit the seller? Additional costs can befall the seller with an FHA loan. However, the process, in general, is no more complicated than that of a conventional loan.
The main reason why an FHA loan could pose a problem for the seller would be in the case of the buyer defaulting on the loan. The seller may potentially be liable to the lender for any outstanding debt not recovered. This is obviously something you would verify with the lender prior to moving forward.
Additional costs are incurred by the seller if any extra repairs need to be made. The property serves as collateral for the FHA- assumed loan and therefore must meet specific livability standards. If not, the onus falls upon the seller to do any necessary repairs in order for the home to pass inspection.
The inspection is done by an FHA-approved appraiser, so it is imperative that the seller keep the home in tip-top shape. Failure to do this could delay the close of escrow, possibly resulting in the loss of sale.
FHA Assumable Loan Considerations
As of the current year, an FHA loan allows the borrower up to 96.5% of a home’s value. These loans are assumable only by applicants with a FICO score of at least 600. In this case, the buyer must go through the same approval process he or she would for a new FHA mortgage.
A note of caution, never enter into an agreement whereby someone else can assume your mortgage without a lender. If, for example, the seller allowed the buyer to simply move in and make payments, he or she would essentially become the ‘land lord’, still responsible for the property and, by extension, the mortgage. This would not be considered an assumable mortgage and could have serious financial consequences, so be careful!
FHA Loan Misconceptions
A common misconception with FHA’s involves the idea that once the loan is assumed, the original owner is liable for it. On the contrary the original borrower is not responsible for the balance if the appropriate assumption transfer documentation has been properly completed.
It is important for the new borrower to understand that he or she accepts the terms of the original mortgage as it was written plus the lender has the ability to make changes to the original loan agreement based upon the new borrower’s credit worthiness.
FHA Loans Assumption Closing Costs
There is an additional benefit to assuming FHA loans and that involves closing cost fees. In many instances the lender of an FHA-approved loan will charge a fee which is considerably less than that of a conventional loan.
Most conventional loans require as much as 20% down whereas FHA mortgages require much less – only 3.5%. In addition, the majority of closing costs can also be included in the loan, with the option of paying off some of these costs out-of-pocket.
In conclusion, FHA loans are absolutely assumable if the new borrower meets the FHA loan qualifications. FHA assumable loans can be a viable option for first time home buyers depending upon the scenario which means assuming an FHA loan will not make sense for everyone. Even with the potential for a lower interest rate, you may be better off applying for a new FHA loan.
Pros and Cons of Assumable Mortgages – Nerd Wallet