Assumption Clause: Meaning, Pros and Cons, Example

What Is an Assumption Clause?

An assumption clause is a provision in a mortgage contract that allows the seller of a home to pass responsibility for the existing mortgage to the buyer of the property. In other words, the new homeowner assumes the existing mortgage and—along with it—ownership of the property that secures the loan. The buyer must typically meet credit and other qualifications and the guidelines for assumption clauses may vary by loan type.

How an Assumption Clause Works

If the interest rate on an existing mortgage is lower than current market rates, an assumption clause becomes an attractive selling point. Also, the buyer can avoid many closing costs, though there are some fees involved in assumptions. Some of the costs will include a title search, document stamps, and taxes.

For most homeowners, the benefits of an assumption clause are theoretical because conventional mortgages generally prohibit the practice. Banks frown on assumption clauses because they write mortgages based on the creditworthiness of the original borrower, not an unknown later buyer.

The new owner's ability to repay may be challenging to evaluate, and the bank may be reluctant to take on their risk. Moreover, even if a bank were to approve the creditworthiness of a new borrower, it would lose out on the down payment and closing costs incurred with a brand-new mortgage.

Special Considerations

As it is rarely in a bank’s interest to allow assumptions, most mortgages include a due-on-sale clause, which demands repayment of the remaining balance when the property sells. The bank won't sign off on its lien until the mortgage is paid, making the sale impossible for buyers who are unable to pay what's due.

However, assumption clauses are standard in government-backed mortgages from the Federal Housing Administration (FHA), the Veterans Administration (VA), and the U.S. Department of Agriculture (USDA). The new owner must still meet credit and eligibility standards.

Advantages and Disadvantages of an Assumption Clause

If you have an opportunity to assume someone else's mortgage loan, it's important to consider the advantages and potential disadvantages of exercising an assumption clause.

Though these types of loans still exist, they may be more difficult to find or to qualify for versus taking out a brand-new mortgage loan. It could also be to your advantage to weigh your options with the best mortgage lenders for getting a new home loan to purchase a property if you're ready to buy.

Pros

Assumption clauses can make the process of buying a home more streamlined and convenient. It may take less time to close on the loan, and the buyer may be getting a mortgage with an interest rate that's below the average current market rate.

Additional money may be saved if the buyer is able to pay less out of pocket toward the loan's down payment or closing costs. If there's no need for an appraisal or home inspection, that's even more money a buyer could save.

An assumption clause could also benefit a home's seller if it makes it easier for them to get out of the mortgage and unload the property. For example, if a member of the military is stationed overseas and their family is going along with them, they may have a pressing need to sell their home quickly. A VA loan with an assumption clause could allow them to do that.

Cons

Assumption clauses can be problematic in the case of VA loans. That's because of something called entitlements, which are tied to the VA guarantee in case of borrower default. If someone has a VA loan and then allows another buyer to assume it, that could affect their entitlement and their ability to qualify for another VA loan.

Buyers can also be at a disadvantage if the loan they're assuming has built-in private mortgage insurance premiums, as is the case with FHA loans.

The only way to remove mortgage insurance premiums from some FHA loans—that is, if your down payment was less than 10% and your loan originated after July 3, 2013—is to refinance into a non-FHA product.

If the interest rate on the new loan is higher than the loan they assumed, the buyer might not realize much in the way of savings simply by removing the mortgage insurance premiums.

Example of an Assumption Clause

Imagine a person who wants to assume the mortgage of a seller who has a 30-year, $240,000 mortgage at 3.5%, on which they have made payments for five years. The remaining balance, including interest, is about $323,300, and 25 years are remaining on the original note.

Assuming the current market interest rate is 4% and the new buyer takes out a 30-year fixed-rate mortgage for the same $240,000 loan, the balance due (with interest) at the end of that time would be about $412,500. Also, the new buyer would need to submit a lump-sum down payment to the financing institution.

By assuming the seller’s existing mortgage, the buyer would save about $89,000 over the term of the loan. Also, there are five fewer years of payment obligation with the assumption-clause loan. Any lump-sum payment would be given to the seller to offset the equity they have built up in the home. Plus, the buyer will avoid thousands of dollars in closing costs.

The Bottom Line

There are many variables when you buy a home, from the interest rate on the mortgage, to whether the closing costs are discounted as part of a deal, and more. Buyers of a home want to ensure they can get the best deal out there as purchasing a home is expensive.

While assumption clauses are not allowed in most conventional mortgages, they can be beneficial if they're available. In a high-rate market, taking over a lower-rate mortgage can save you thousands of dollars. Closing costs can sometimes be high and are nice to avoid, which you can also get through an assumption clause.

It's always best to shop around and see what deals are available in the market to ensure you are paying the least amount possible for your home.