There are not many assumable loans available on the market, but the USDA loan offers this benefit. This means you can take over the previous owner’s USDA loan where they left off. It sounds simple, but there are many factors at play here. You need to consider each of them before deciding if assuming a loan is right for you.
What Assuming a Mortgage Loan Means
When you assume a USDA loan, you take over it as if the original mortgage holder never stopped making payments. You take on the remaining term as well as the interest rate and equity in the home. You do not have to apply for a new loan – you get whatever the seller has on his USDA loan. This is a great way to save on closing costs. Since you are not taking out a new loan, the costs greatly decrease.
How Assumable Loans Work
If you decide you want to take on an assumable loan, the home and the mortgage get transferred into your name. As soon as the process is complete, meaning you go through the closing process, the seller is no longer liable for the mortgage. You are the owner of the mortgage and are liable for the payments. You are known as the assumptor.
How to Qualify for an Assumable USDA Loan
Qualifying for an assumable USDA loan is not much different from qualifying for any other type of loan. You cannot just say you want to take over the loan and receive approval. The lender still needs to approve you for the loan. They need to make sure you are not a serious risk that would put the bank at risk for default.
For starters, the USDA has to approve the assumption. They will only consider it if the current owner is current on his payments. If the seller is behind, an assumption is not a possibility. Chances are you would not want to assume a delinquent mortgage anyways. Once the USDA determines the mortgage is not delinquent, they need agreement from you to assume the entire mortgage, no matter the amount of the equity in the home at the time.
The next step is gaining approval from the lender. This is where the similarities to any other loan application come into play. You will have to meet each of the USDA guidelines, which include:
- A minimum credit score of 580; however most lenders want credit scores of at least 620. If your score is lower than 620, the loan file will go through extra scrutiny.
- Your household income does not exceed 115% of the average medium income for your area. The lender can determine this for you or you can visit the USDA income guidelines to see if you meet the requirements.
- Your debt ratio should not exceed 29/41. This means your mortgage payment cannot be higher than 29% of your monthly income and your total monthly debts cannot exceed 41% of your monthly income.
When you calculate your gross monthly household income, make sure to take advantage of the allowances the USDA allows. They are as follows:
- Any child under the age of 18 or over the age of 18 and is a full-time student provides you with a $480 allowance for each child
- Any disabled family members living with you provide you with a $480 allowance
- Any elderly family members living with you provide you with a $400 allowance
The allowance is directly subtracted from your gross monthly income. If you currently make more than 115% of the average income for your area, the allowances may help you qualify.
USDA guidelines are rather simple to meet and do offer plenty of flexibility. As long as you have “decent” credit and are not in over your head in debt, you should be able to secure approval.
Reasons to Assume a USDA Loan
You might wonder why you would want to assume a USDA loan. Shouldn’t you just get your own? Aside from the fact that you will save money on closing costs, there are other benefits of assumable loans:
- Obtain a lower interest rate – If the current interest rates are higher than the rate the current owner has on his mortgage, you could assume the loan and take advantage of the monthly savings
- Save on the upfront funding fee – The current funding fee is 1% of the loan amount. This might not sound like a lot, but if you have a $150,000 mortgage, you could save the $1500 funding fee plus the closing costs
How the Seller Gets Paid
The seller likely has equity in the home, which he will want to receive at the closing. Because there is not a new mortgage being funded, there is no money at the closing table. This means the buyer must come up with the money. This could be in the form of cash or as a second mortgage. If the buyer does not have the cash to cover the equity, the 2nd mortgage is the only way to go. This could get rather costly if the seller has significant equity in the home. For example, if the seller owns a home worth $200,000 and owes $100,000 on it, the buyer must come to the table with $100,000. It is best to assume mortgages where there is not a lot of equity in order to minimize the amount of money you need.
The assumable USDA loan is a great choice for some people, especially when interest rates are higher. It is always worth looking into the possibility of assuming a loan to see if you could save some money. Even if you only save on the closing costs and funding fee, you start homeownership off with a little more money in your pocket, helping you to have an emergency fund for the future.