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Assumable Mortgages – A Key VA Advantage

You may have heard your real estate agent or mortgage lender mention that your Veterans Administration home loan is “assumable.” That doesn’t mean much, unless you are looking to sell the property, or possibly to acquire someone else’s property. But the fact that VA mortgages are, in fact, assumable, is a potentially very valuable feature.

I say “potentially,” because current market conditions make it very tough to unlock a lot of value in that feature. But it’s good to keep in mind for the future.

Let’s look at how it works:

When you “assume” a mortgage, you are essentially just taking over the debt for someone else. You are agreeing to make all future payments on the mortgage, just as if you had taken the loan originally.

VA home loans are assumable, as are FHA mortgages. Conventional home loans are not typically assumable. That is, the lender does not normally agree to allow a new borrower to take over the payments. They would rather underwrite and issue a new loan from scratch – at today’s interest rates.

In today’s environment of extremely low interest rates, you probably wouldn’t see many assumable mortgage transactions. That’s because as of this writing, 30-year rates on fixed mortgages are around 3.75 percent, on average. That’s about as low as it gets. (Adjustable rate mortgages are even lower, but the borrower assumes more risk).

Fed Chairman Ben Bernanke has announced the decision to hold rates to rock bottom at least until 2015, in the effort to boost home demand and stimulate the economy. But at some point in the future, interest rates are likely to rise. It’s simply the principle of reversion to the mean.

And when that happens, the assumable mortgage transactions will heat up.

Why do people assume mortgages?

One great reason to assume an existing mortgage, rather than take out a new loan, is interest rate arbitrage: If the interest rate on the existing mortgage is significantly lower than the prevailing market interest rate interest for a new one, that can save the buyer hundreds of dollars per month.

Since their costs are lower with an assumed mortgage than with a new one, they would much rather assume than apply for a brand new loan.

They should therefore be willing to split part of that benefit with you, as the seller. They will pay you a good part of the net present value of the difference in interest rates.

This means that when rates rise, you will likely effectively get a “bounce” in the value of your home thanks to the value of an assumed mortgage.

Turning the equation around, if you are looking to buy a house after rates have gone up, you might want to start your search with existing assumable mortgages, which can create a potential “win-win” for both buyer and seller.

Who loses? The lender. All lenders face something called “reinvestment risk.” This is the risk that money they receive as loans are paid off cannot be reinvested at the same rate as the current loan. This causes banks headaches because if more people pre-pay loans, they have to lend the money back out – and they can’t necessarily get the same stream of income from that money as they did before. For example, they would much rather receive 6 percent interest on a $200,000 outstanding balance on an old loan than 4 percent on the balance of a new one.

Who Can Assume a Mortgage?

It depends. For VA loans, anyone can assume a mortgage if the mortgage closed prior to 1 March, 1988. For FHA loans, the magic date is December 14, 1989. So the good news is that anyone can take over a VA or FHA loan as long as it’s a relatively older one.

For loans after that date, the loans must be approved by the lender.

The bad news is this: It’s still a federally guaranteed loan. So if you sell to someone who’s taking over the payments on one of these loans, the federal government will come after you.

Unless you can get a formal “release of liability” from the lender, in writing, this could cause you a lot of problems. For example, the loan will count against your debt-to-income ratio – even though you get no real benefit from the appreciation or use of the home anymore. That will make it tougher to get a home mortgage in the future.

And you can’t normally discharge a VA mortgage by declaring bankruptcy. If you default on a VA mortgage – or of the person who assumes the mortgage from you defaults, Uncle Sam will come looking for you, and will be docking your tax refunds until the cows come home – or until you pay of the debt, whatever comes first.

The time isn’t right yet for you to worry much about assumable mortgages. But when mortgage interest rates rise again – as they are almost certain to do, eventually – you could get a substantial boost from being able to sell an assumed mortgage.

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