Assuming a Mortgage Loan

Here is almost everything about mortgage assumption and taking over payments that casual buyers and sellers of real estate or large expensive property might want to know.

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Most mortgage loans are "not assumable" as far as the bank is concerned, but some people try to "assume" them anyway.

There are three methods of allowing the buyer to take over the payments on an existing mortgage loan (or car loan or other loan with collateral). The terminology may differ, we give the terminology as used in Hawaii in the 1980's.:

1. Purchasing the property subject to the mortgage. The seller (and/or others previously responsible for the loan) remains responsible, actually the buyer is not liable to the lender except that the property itself may be lost to foreclosure.
2. Assuming the mortgage loan (ordinary assumption). Both seller and buyer are responsible for making the payments to the lender.
3. Assuming the mortgage loan with novation. The seller is released from liability, the buyer is responsible for making the payments.

Method #1 does not require notifying the lender let alone any action on the part of the lender. The balance owed is treated as part of the purchase price and the buyer pays the rest as a down payment (or gets a second mortgage loan). It is not desirable for the seller of property to use this method although sellers anxious to sell quickly have used it.

If the lender permits assumption of the loan, he/she would have no problems with method #2 as it better assures that the loan will be repaid. In most cases it is necessary to notify the lender and pay a nominal fee, say, USD $100.

No lender is obliged to approve method #3. No prudent lender will approve method #3 without doing a thorough financial background check on the buyer, or person assuming the loan.

Whether or not the buyer wants to assume a mortgage loan will almost always become known to the seller quickly because the purchase and sale agreement should specify how the buyer intends to pay for the property including how much time the buyer is given to get a new loan commitment.

If the buyer does not indicate a desire to assume an existing mortgage loan on the purchase and sale agreement, the seller can expect that the buyer will not try to do so using methods #1 or #2. The seller should still keep track of the buyer's progress in obtaining financing, including getting a copy of the new loan commitment, so there are no unexpected surprises on closing date and also if financing fails the seller can put the property back on the market more quickly.

The seller may prohibit the buyer from using methods #1 or #2 even if the lender does not. To do this the seller simply stipulates in the purchase and sales agreement that the purchase price is to be paid in cash or certified check. Alternatively the seller, if s/he notices a desire of the buyer to assume in the purchase and sale agreement, stipulates on said agreement that a statement of intent to release the seller from the mortgage loan must be part of the closing. (The actual release will not occur until after the closing when the old mortgage loan is actually paid off.) This will force the lender to deal with method #3 which in turn might end up with the buyer's being unable to assume the loan. (It may also result in the sale's falling through, so some sellers don't demand a release but instead advertise that the mortgage loan is assumable if it is.)

The seller takes home from the closing the same amount of money with or without an assumption of the mortgage loan. Let's imagine a property selling for $100,000. and the mortgage balance is $60,000. Without assumption, the buyer with the help of the new lender pays the seller $100,000. but $60,000 is withheld immediately to pay off the old mortgage loan. The seller thus takes home $40,000, less applicable closing costs and fees and taxes. With assumption, the seller only owned $40,000. worth of house (his/her equity is $40,000.) so the buyer gives the seller $40,000 (minus the same applicable closing costs, taxes, etc.) and the buyer takes over the $60,000. debt.

Due On Sale

A loan is assumable under methods #1 and #2 unless the loan note or mortgage specifically prohibits it. Prohibition by the lender is accomplished by what is commonly referred to as a "due on sale clause" or "alienation clause" which looks something like this:

"Transfer of the Property or a Beneficial Interest in Borrower: If all or any part of the property is sold or transferred without Lender's prior written consent, Lender may, at its option, require immediate payment in full of all sums secured by this Mortgage..."

A loan is considered to be not assumable if permission is required of the lender for methods #1 or #2 above as evidenced by the presence of a due on sale clause in either the loan note or the mortgage document. A loan for which there is no due on sale clause is still considered assumable even if the seller won't let the buyer assume it under method #2.

Almost all conventional (not under programs such as FHA or VA) mortgage loans made after 1980 are not assumable. Almost all FHA and VA mortgage loans prior to 1980 and most of them after 1980 are assumable. Since a rapid rise in interest rates that occurred around 1980, lenders have been reluctant to allow lower interest rate loans to continue in effect as property changed hands. Preventing the assumption of such loans allowed lenders to write new mortgage loans at higher interest rates. If interest rates are high, lenders will often require a change to a higher interest rate as a condition of assuming a loan, although the buyer usually does not have to pay points or closing costs.

Getting Around Due On Sale Clauses

Buyers and sellers of property have used ingenious and/or surreptitious means of assuming mortgage loans. The most common is simply not notifying the lender, which is a method #1 situation. The buyer takes the chance the bank will find out and foreclose immediately.

Another mechanism is for the seller to retain ownership but enter into a contract whereby the seller must deliver the deed when the loan is paid off. This latter mechanism is termed "agreement of sale" in Hawaii and some other states, and "bond for deed" in Massachusetts and some other states. The buyer pays the seller and the seller pays the lender. One problem is that the seller still owns the property and a subsequent lawsuit brought against the seller or failure of the seller to pay the lender may result in loss of the property. The two aforementioned states have laws that put the buyer ahead of subsequent creditors as far as acquiring the property goes in the event the seller gets into financial difficulty later. Buyers in other states should research the laws of their state to determine what buyer consumer protections exist. The "agreement of sale" is typically for a period of five to ten years after which the buyer is expected to take out a new mortgage loan.

As is with any aspect of a loan or mortgage, making a loan assumable by removal of the due on sale clause is a negotiable issue between borrower and lender.

Car Loans, Mobile Home Loans

In the early years of a loan, most of the payment covers interest; in later years, most of the payment pays the principal (the amount owed). At any point in time, the amount owed can be calculated, and the formula varies from one loan to another and from one lender to another. What most people don't realize is that the amount owed does not go down as fast as they think in the early years. In many cases, the amount owed on a car loan exceeds the value of the car for much of the life of a car loan. Therefore "taking over the payments" as the purchase price is often not a good deal for the car buyer.

Even though the car loan note has a due on sale clause (is not assumable), a lender who refuses to permit a prospective car buyer to take over the payments may be barred from collecting a deficiency from the prospective seller if the seller was delinquent, the car is repossessed but it doesn't fetch enough to cover the loan. State law varies and it is up to the car owner to make a case for this.

Terms, as a reminder:

The mortgage is the agreement by which the property is made collateral for a loan.

The note (loan note) is the agreement to repay the loan.

The mortgagor (pronounced as if spelled "mortgageor" is the person, usually the borrower, who gives the mortgage.

The mortgagee is the person, usually the lender, who takes and holds the mortgage, and has the right to foreclose.

When the seller agrees to accept monthly payments from the buyer as part of the purchase price, and a mortgage and loan note are drawn up, the seller is said to take back a mortgage.

Giving a mortgage is in a sense giving away title to the property, and the mortgage document is technically known as a mortgage deed. The distinction from an ordinary deed is that the mortgagor keeps full use of, possession of, and responsibility for, the property and the mortgagee has no use or possession of the property unless or until the loan agreement is breached by the borrower and foreclosure takes place. When the loan agreement is satisfied, the mortgagee cannot take possession of the property under the terms of the mortgage although satisfaction of the mortgage, a.k.a. discharge of the mortgage, must still be recorded in the office where the deed was recorded.

Home Sale Pending, Seller Went Bankrupt

In this case discussed on the Tom Martino talk show, the buyer called in and asked for advice on expediting the closing which was delayed because the seller had filed for bankruptcy.

The property remains an asset of the seller and falls within the control of the bankruptcy court. The creditors have the right to prevent the sale of the property if they feel that a better purchase price could be obtained by selling to someone else. The bankruptcy attorney would advise the creditors and the court would grant or deny permission for the closing to proceed, of course taking into consideration the added time it might take to find a new buyer.

The buyer may offer more money to encourage the creditors to let the sale proceed.

In the actual case discussed on the show, the buyer had already moved into the house (after a short stay in a motel). While the seller is not liable to the buyer for added costs because of the delay in closing, the buyer is probably not liable to the seller or the seller's creditors for rent over and above rent already agreed upon. The buyer should contact his own attorney on this point.

The buyer may back out of the sale also, when the closing does not occur within the time constraints specified in the purchase and sales agreement. A buyer is likely to back out if the delay in closing resulted in an increase in the interest rate for the buyer's proposed financing. Neither the seller nor the buyer would be liable to the other for expenses as a result of the cancellation of the sale.

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