What is Co-Managed Care for Veterans?

Emerging Opportunity: Assumable VA Mortgages

It’s still very early in the game, but we may well be at the beginning of a cyclical increase in mortgage interest rates. That creates an opportunity for people who own homes with outstanding VA mortgages – and FHA mortgages, too, for that matter. Here’s why:

Mortgage interest rates have been extremely low for quite a while now. They hit their all-time low of just over 3 percent at the end of last year, and brushed against those lows again last spring before starting to edge upwards again.

The Federal Reserve has been seeking to keep mortgage rates very low in order to boost the flagging real estate market and support the sluggish economy. But the housing market experienced a strong price recovery last year that seems to be continuing. This, combined with a slowly improving broader economy, takes a lot of the pressure off of the Federal Reserve to artificially keep rates down. As a result, it is looking increasingly likely that interest rates will continue to rise.

A rising interest rate environment creates an opportunity for VA mortgage holders to exercise one of their rights under the mortgage contract: assumability.

In plain language, assumability means that anyone with a VA loan who wants to sell the house has an option to simply let a new borrower take over the mortgage and keep making payments. They just assume the mortgage - picking up the payments where you leave off.

That doesn’t make very much sense when interest rates are falling: The buyer can typically qualify for a lower rate than the existing loan simply by getting a new mortgage. But when interest rates have been rising, the seller has something very desirable from the buyer’s point of view: A comparatively cheap loan. That’s a powerful negotiating point for the seller, and buyers will pay up for it.

Here’s how it works: Suppose you were able to get a 4 percent mortgage last year and finance $200,000 on a house, with nothing down. Your payment on this loan is $954.84 per month. But in a few years you want to move or it’s time to PCS. Meanwhile, mortgage interest rates have increased from 4 percent to 8 percent.

Now, you have a buyer who needs to finance the property. Let’s say he needs to borrow $150,000, with 300 months left on the original 360 month loan. The buyer could go and get his own loan, but he’d have to pay the prevailing loan rate at 8 percent. That means his loan payment would be sharply higher than yours, at  $1,157.73.

This is where you say, “Wait a minute, I have a VA loan. It’s assumable. So you can just take over my payments and save $202.89 per month, or $2,434.68 per year!” Obviously this is worth quite a bit of money to they buyer over the remaining 300 months of the loan. In fact, the buyer will save $60,867 over the course of the loan.

Now for a bit of finance theory: Money in hand now is worth more than the promise of money in hand in 300 months. This is the central premise behind a concept called the time value of money. So it’s not exactly worth $60,867 to the buyer to save $60,867 over the life of the loan. But it’s worth a lot more than nothing! And I’m sure you’d rather that money was in your own pockets than in some lender’s!

So here’s what we do: We discount that $60,867 back to the net present value. That’s the value of the proverbial “bird in the hand” as opposed to “two in the bush.” If the prevailing interest rate at the time of the sale is 8 percent (it’s no accident that that’s the same as the prevailing mortgage rates in our scenario!). Saving $202.89 per month is mathematically equivalent to receiving a monthly income of that much (we’re disregarding taxes here, because the IRS only taxes money you receive, not money you save). So using a spreadsheet developed by real estate expert and columnist Jack Guttentag (you can download the spreadsheet at the link), the net present value of the assumption itself at the time of sale would be $49,337.75. This is the theoretical check someone would be willing to write for the certainty of that stream of money for 300 months.

Remember – assuming your mortgage also saves the buyer origination fees, which can add up to two or three thousand dollars on a $150,000 loan. So it’s probably worth it to a forward-thinking buyer to pay up to $52,337.75 dollars extra for the privilege of assuming your mortgage.

Now, you probably won’t get the full amount. You probably want to leave enough on the table for it to be an easy decision for the buyer. You want him to jump at the idea, because that’s more money in your own pocket. Split the difference and have him write a check to you for half the net present value or so, and you have a very easy win-win: You get extra cash now, and the buyer gets a lower monthly mortgage payment for the next 300 months, in our scenario.

Incidentally, the lender typically will not require an appraisal to go forward with an assumed mortgage transaction. That saves about $400 or $500 per home right there.

Naturally, your situation will vary, so be sure to do the math as it applies to your specific situation. The spreadsheet will help.

Now, assumption isn’t automatic. The buyer still has to qualify for the loan. They have to have decent credit, an acceptable debt-to-earnings ratio, and jump through all the normal hurdles to qualify for the loan just as you did.

WARNING: Normally, if a buyer assumes a VA mortgage and doesn’t pay, then you are still on the hook for the outstanding balance. Always, always get the lender to release you, in writing, from responsibility for an assumed mortgage before finalizing your sale. Make any contracts contingent upon either payment in full so you can pay off your own mortgage, or on the formal release of liability from the existing VA or VHA lender.

It’s too early in the interest rate cycle at this writing for there to be very many opportunities for assuming a mortgage to make sense. But as interest rates rise, there well be more and more scenarios where an assumed mortgage is something worth serious consideration.

One last thing to keep in mind is that you can only have one VA loan out at a time. Until the old loan is paid off – whether by you or by the person who assumed the loan – you generally will not be able to qualify for another VA loan. That is, unless the buyer was also a veteran. That buyer can use his or her own entitlement in assuming the loan. This frees your VA loan eligibility up to go buy your new home.

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