Homebuyers

What Is an FHA Assumable Loan? How It Works and Who Qualifies

When financing a new home, many buyers follow the traditional path. They choose a lender and apply for a mortgage. However, another valuable option currently offered to buyers is assuming the existing mortgage. Assumable loans let homebuyers take over the seller’s mortgage when buying a home.

Assumable loans can help both the buyer and seller.

The highly popular FHA loans, governed by the Federal Housing Administration, fall under this category, too. However, you must meet specific criteria to successfully apply for an FHA assumable loan.

Find out what these criteria are. Learn how an FHA assumable loan works. See the many potential benefits below.

Are FHA Loans Assumable?

Yes, FHA loans are assumable. Every mortgage issued by the FHA is assumable, allowing first-time homebuyers with credit limitations another avenue to homeownership.

Unlike other FHA loan transactions, an FHA loan assumption follows a different process. Firstly, the lender must ensure the person assuming the loan possesses good credit through the underwriting process.

As with other loans, lenders will review your debt-to-income ratio as well. Lenders want to make sure the borrower is financially able to take over the loan and is likely to make the mortgage payments.

Additional requirements may also apply depending on when the original mortgage was issued.

Further, any FHA loans issued before December 1, 1986, are ‘freely assumable.’ This means there are no limits on new assumptions. This can make older homes more appealing to people looking for a new home.  

What is an Assumable Mortgage?

An assumable mortgage allows an eligible homebuyer to take over the seller's existing home loan instead of taking out a new mortgage. The remaining loan balance, mortgage interest rate, repayment term, and monthly principal and interest payments generally stay the same. The buyer simply assumes responsibility for repaying the loan, subject to the lender's approval.

Assumable mortgages often become more attractive when current mortgage interest rates are higher than the rate on the seller's existing loan, allowing eligible buyers to secure a below-market mortgage rate.

Different loan types can successfully be assumed when all their criteria are met, including USDA, VA loans for veterans, and FHA loans.

How Does an Assumable Mortgage Work?

While an assumable mortgage allows a buyer to acquire the remaining balance of the principal loan, it does not factor in equity. If a particular home has gained value since the original loan was issued, the buyer will need to pay the difference—or home equity—with cash or another loan.

An assumable FHA mortgage works in the same way, but a buyer will need to meet certain criteria before taking over an existing FHA mortgage. Among these criteria, a buyer will need a credit score of at least 580 and a debt-to-income ratio of 43% or less.

Buyers should also understand that assuming an FHA loan isn't automatic. The lender must approve the assumption and verify that the buyer meets the loan's credit and income requirements. Additional requirements may also apply depending on when the original mortgage was originated.  

Can Family Members Assume FHA Loans?

Yes, family members can assume an FHA loan if the borrower chooses to transfer it to a relative and the Department of Housing and Urban Development (HUD) has given permission.

If a spouse wishes to assume their significant other’s FHA loan, they will need to prove their creditworthiness to the FHA while meeting their standards. The same is true for a child wishing to take on their parent’s FHA loan.

Additionally, extra steps will need to be taken for related persons, not on the title to gain ownership of the property.  

Benefits of an FHA Assumable Loan

Assuming an FHA loan can help eligible homebuyers save money by securing a lower mortgage interest rate and potentially reducing their monthly mortgage payment. Four excellent benefits of assuming an FHA loan are:

• Likely Lower Interest Rate: If interest rates have increased since the original FHA loan was first issued, assuming a loan can be a big advantage to a homebuyer. This could allow them to avoid paying these high rates or even higher rates in the future.
• Lower Closing Costs: When a buyer takes on an assumable FHA mortgage, they can save a large amount of money on closing costs. Some closing costs will still have to be paid, like the mortgage lender’s assumption fee, but the total closing costs will most likely be lower than with a new mortgage.
• Chance to Remove MIP: If the original FHA loan was issued before July 3rd, 2013, the mortgage insurance premium (MIP) has a chance to be removed after the remaining loan balance drops to 78% of the original purchase price.
• Possibly Optional Appraisal: After assuming an FHA mortgage, the original lender of the FHA loan will usually not require a new appraisal.

Check out the current mortgage rates here.

When is an Assumable FHA Loan Bad for the Buyer?

If a potential homebuyer is looking to purchase a new home, they will need to be aware of the home’s value. In some cases where there has been an increase in the home’s value or if the seller has paid a large amount of the mortgage balance, the buyer will be required to pay a larger down payment.

If the down payment that a buyer must pay to assume an FHA loan meets or exceeds 20%, they could instead qualify for a Conventional loan that does not have private mortgage insurance (PMI). 

Is an FHA Assumable Loan Bad for the Seller?

There are pros and cons to all loan options, and mortgage assumption should always be considered together.

An FHA assumable mortgage may be bad for a seller in situations where the buyer defaults on the loan. If this occurs, the seller may be liable to the lender for outstanding debt that has not been recovered. To avoid this situation, sellers should discuss this with their lender to verify this before continuing with the FHA loan assumption process.

An FHA loan assumption can also create delays if the lender requires additional documentation or determines that certain conditions must be met before approving the assumption. Although assumptions are often simpler than obtaining a new mortgage, buyers still must qualify for the loan, and the approval process can take time.

FHA Assumable Loan Considerations

Federal Housing Administration (FHA) loans allow eligible homebuyers to finance up to 96.5% of a home's value with a minimum 3.5% down payment, provided they meet the program's eligibility requirements.

In most cases, borrowers need a credit score of at least 580 to qualify for maximum financing, although lenders may impose additional requirements.

For most FHA loans originated on or after Dec. 15, 1989, the buyer must qualify with the lender before assuming the mortgage. The lender reviews the buyer's credit, income, employment, and other financial information much like it would for a new FHA loan. Gathering financial documents, such as proof of income, tax returns, and bank statements, ahead of time can help the assumption process move more smoothly.

Each lender or banker will also have their own set of applicable eligibility and qualification requirements.

FHA Assumable Loan Misconceptions

The idea that an FHA assumable mortgage does not remove original owners from loan responsibility is not true (under certain circumstances). If the original borrower signs the needed loan transfer documentation, then they will not be liable for the remaining balance.

An example of this would be if the new borrower loses the ability to make the monthly payments and defaults on repaying their assumed loan. Normally, and without the proper paperwork, the seller would be liable. With the paperwork completed, though, this situation will not arise.

FHA Loan Assumption Closing Costs

Typically, FHA loan assumption closing costs are between 2% and 6% of the home’s sale price. This is usually much less than the closing costs associated with Conventional loans (which can total as much as 20%).

The payments and fees associated with an assumable FHA loan also include the upfront mortgage insurance premium, as well as all prepaid items such as homeowners’ insurance, property taxes, service fees, and the initial escrow deposit.

In addition, buyers should keep in mind that related closing costs vary by state and are much higher in states with high tax rates. Speak to a loan officer at New American Funding before the FHA loan assumption to have them prepare a loan estimate so you can understand exactly what prices to expect from closing costs.

FHA loans are timely right now, so considering an assumption can be highly beneficial. However, both buyers and sellers should be aware of the differences between applying for an FHA loan and the process around assuming one, so an in-depth talk with a mortgage lender for both sides may be a wise idea.

If you are interested in applying for an FHA loan instead of assuming one, or in any of our other programs and listed products, our loan officers at New American Funding will be happy to help you find the right loan to fit your needs.

You can also use our mortgage calculator to estimate your loan costs and payments.