How assumable mortgages can get you a rate from 10 years ago — if you can find one

With mortgage rates nearly double what they were in 2021, homebuyers are getting hit with a double whammy.

Higher interest rates have increased home-financing costs. At the same time, homeowners are hesitant to move and give up their low mortgage rate, which contributes to the housing inventory shortages keeping home prices high.

One potential solution is assumable mortgages, where the buyer takes over the seller’s existing loan and keeps its interest rate and repayment terms. Approximately 85% of properties have loans with a mortgage interest rate below 5%, according to Redfin. This represents a potential for significant savings for buyers and could make it easier for owners to sell their homes — but assumable mortgages also come with some catches. Let’s take a look at how they work and when this home-financing strategy could make sense for you.

With an assumable mortgage, the buyer takes over the seller’s mortgage and keeps its interest rate, remaining payment schedule and loan balance. When rates are increasing, assuming an older mortgage loan can be a great way to secure a mortgage rate that’s far below what you could qualify for if you applied for a new home loan.

To assume a loan, the buyer must meet the lender’s qualification standards. This process is essentially the same as applying for a standard mortgage — the lender reviews the buyer’s credit history, debt-to-income ratio (DTI) and other financial information. Because an appraisal of the home isn’t typically required, the application process usually moves quicker than normal and can be less expensive in terms of fees.

However, you have other factors to consider before building your homeownership dreams around assuming a mortgage with a 3% interest rate. For one, most mortgages aren’t assumable. Typically, only government-backed loans are assumable and the majority of mortgage loans are conventional. During the past three years, government-backed loans have only accounted for roughly 18% to 26% of residential loan applications, according to the Mortgage Bankers Association’s Weekly Applications Survey.

If you want to assume a mortgage, the seller needs to have one of the following types of mortgages:

Assuming an existing mortgage means balancing the benefits with the tradeoffs. On one hand, assuming a mortgage can be a cost-effective way to finance a home purchase. But It can also significantly increase your down payment.

Pros

• A potentially lower mortgage rate
• Can have lower fees
• Easier to find a buyer (when you’re ready to sell)

For a buyer, the advantages of an assumable mortgage are obvious, especially when rates are rising. And if the loan has lower upfront fees, it’s an even better deal for the buyer.

Sellers with an assumable loan carrying a favorable interest rate may attract a larger pool of potential bidders. It’s like having an extra bedroom, says Ted Tozer, a nonresident fellow at the Urban Institute’s Housing Finance Policy Center. “It’s something that differentiates you from the marketplace.” And to get a hold of that cheaper mortgage loan, buyers may make higher offers on the property.

Cons

• May need a second mortgage with its own upfront fees
• May require a bigger down payment

Aside from the fact that most home loans aren’t assumable, there’s another big reason why assumable loans aren’t more popular — the down payment.

Government-backed loans usually have smaller down payment requirements. VA loans and USDA don’t require any down payment and you can get an FHA loan for as little as 3.5% down. But you’ll need to make a much larger down payment — at least 15 %, according to Tozer — when assuming one of these loans.

The reason is, an assumable loan rarely covers the full purchase price of the house. That means the buyer needs to come up with the difference. Part of the price difference could be covered by a second mortgage, but second mortgages are riskier for lenders (because if you default, the first mortgage gets paid before the second). So a second mortgage will typically only cover up to 85% of the value of the home. That means the buyer will have to pay the rest out of pocket.

An easy way to think of it is, when you combine the assumable loan, second mortgage and down payment, they need to equal the home’s purchase price. For example, if you assumed a $200,000 mortgage on a home that sold for $350,000 and then took out a second mortgage of $97,500, you would need to pay a down payment of $52,500 (350,000 – 200,000 – 97,500 = 52,000) to seal the deal.

Another factor to pay attention to is the cost of a second mortgage. These types of loans typically have higher interest rates than the first home loan that’s attached to a property and have additional upfront closing costs. So you’ll want to make sure the closing costs, monthly payment and mortgage rate on a second loan don’t outweigh the potential savings from assuming an existing mortgage. Also, it’s more difficult to qualify for a second mortgage because the lender assumes more risk than they would with a first mortgage.

It’s always important to shop around for a mortgage and compare offers from multiple lenders. That’s true whether you’re assuming a loan and shopping for a second mortgage or getting a brand new home loan.

When it comes to home loans, there’s a tradeoff between mortgage rates and fees. You may be able to get a lower interest rate if you pay higher fees and vice versa. Pay close attention to both and consider the best fit for your goals and budget. One way to potentially save on upfront costs is to compare quotes with lenders that don’t charge origination fees, like PenFed Credit Union or Ally Bank (although other fees apply).

Keep in mind, not all lenders offer second mortgages. So if you’re looking for a second home loan to supplement an assumed mortgage, you may have to search more than you expected. But comparing a large number of lenders has other benefits as well because each one offers different types of mortgage loans.

Mortgage loans backed by the government, like VA loans or FHA loans are usually assumable. When interest rates are rising, assuming an existing mortgage loan can allow buyers to secure lower-cost financing.

However, the buyer may need to secure a second mortgage on the property and make a larger down payment to close the deal. These extra upfront costs may not be in your homebuying budget, especially if you’re a first-time buyer relying on a low- or no-down-payment loan.

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