If there’s one thing different loan programs have in common, it’s that they can’t be assumed. USDA loans, however, are the exception to the rule. They are an assumable loan. This means someone else can take over the loan where you left off or vice versa. We discuss what this means and how it works below.
What Happens When You Assume a Loan?
Assuming a loan means you basically start where the seller left off in the mortgage. You keep the same term, interest rate, and payment amount. You start making payments where the seller stopped. It’s a great way to help you keep the loan affordable. It’s not a new loan, so you also often save on the costs of taking out a new loan.
How do You Assume a Loan?
Now comes the hard part. How do you assume the loan? You must qualify for it. Even though you are essentially taking over where the seller left off, you still have to qualify for the loan. The lender holding the loan is the one who must approve you. The lender looks over your qualifying factors to make sure you aren’t a high default risk. This is much the same as you would do for a new loan.
- The Seller’s Part – The first consideration is the seller and how current they are on their payments. A seller who is in default already poses a risk to the lender. It’s unlikely that the lender would let someone else take over an already risky loan. This protects you as the buyer too, though. The last thing you want is to take on a loan that is in default. Not only will there be back interest; there may also be a variety of fees you would have to pay. These are fees for something you didn’t even do.
- The Buyer’s Part – As the buyer, you must agree that you will take on the whole loan. You can’t assume just part of the loan. Wherever the seller left off is what you agree to take on.
Qualifying for the Assumed Loan
Qualifying for the assumed loan is similar to the process you would go through to qualify for a USDA loan on your own. You must meet the following requirements:
- Your credit score shouldn’t be below 580. This varies by lender, though. A 580 credit score is the USDA’s requirement. Most lenders require a slightly higher score. A good average is 620. Ask the lender holding the loan what credit score they require to find out for sure.
- You can’t make too much money. The USDA loan is for low to moderate income families. This goes for families that try to assume the loan too. You can see the USDA’s income guidelines here. Basically, you can’t make more than 115% of the average income for your area. This includes all income from anyone in your household.
- Your debt ratios shouldn’t exceed 29/41. This means 29% of your income can cover your housing expenses. It also means 41% of your income can cover your total expenses. Anything beyond these numbers could render you ineligible for the USDA loan assumption.
Why Would You Want an Assumable USDA Loan?
Many people wonder why they would take over someone else’s loan. Doesn’t it make more sense to take out your own? In some cases it does, but there are benefits to the assumable loan.
- If the current interest rates greatly exceed the rate the seller has on their loan, assuming the loan makes sense. You save money on interest. This provides you with savings right off the bat. It’s not a bad deal.
- You save on closing fees. For starters, the USDA loan charges a 1% funding fee at the onset of the loan. If you assume a loan, though, you don’t pay this. It’s only charged on new loans. Assuming an old loan doesn’t count. You may also avoid other closing costs lenders charge, saving you money in the long run.
The Downside of Assuming a USDA Loan
Of course, there is a downside of assuming a USDA loan – you must come up with the money to pay the seller. With a traditional mortgage, you borrow as much as you need to pay the seller. You only need money for the predetermined down payment. Basically, you pay the seller the amount of equity he has in the home. You can pay it in cash. If you don’t have the cash, you can take out a 2nd mortgage. This may be harder to qualify for, though.
Let’s look at an example:
John wants to buy a home that has a USDA mortgage on it. The asking price is $150,000. The seller owes $50,000 on the home. This means the USDA loan only has $50,000 left on it. John can assume the loan because his income doesn’t exceed 115% of the area’s median income. But, first John must pay the seller the $100,000 in equity. If John doesn’t have the money, he must take out a home equity loan or line of credit. You close both loans at the same time. This way the seller gets paid and you take possession of the home.
The Final Word
Should you consider assumable loans? It’s a personal decision. There are reasons you may want to consider it. This is especially true if interest rates are high right now. It’s not a solution if you have bad credit or a high debt ratio, though. You still have to deal with a lender and get approved for the loan. The difference is you save money in the long run.
If you have money set aside and can pay the seller in cash, it may make sense. If, however, you have to take out a 2nd mortgage to pay the seller, it may not make sense. Look at the difference in payments between a new loan and the assumed loan. Take into consideration the cost and interest on the 2nd mortgage. Then you can determine what is right for you.
Because you can’t shop around for different lenders with an assumed USDA loan, you must deal with what the lender provides. Compare this option to a new loan to make sure you get the deal that is best for you.