Financing (part 5) - Assumptions

To assume a loan means you are legally taking over responsibility for its payment. In other words, you are agreeing to take on someone else's loan, transfer the obligation to you, and make the payments from that point forward. When available, assumable loans are just about an investor's best friend!

The Good Old Days!
There is an issue, however. Prior to the mid 1980’s all government loans were assumable, and many conventional ones were as well. At one time, there were even many "non-qualifying" assumable loans for which you only had to sign your name to take over.

Assumable Loans Today
By the end of the 1990’s most existing assumable loans were either paid off or refinanced away. And, nearly all new loans, conventional or government had clauses denying the ability for someone to assume the loan (these are called a due on sale clauses). So, you have the compound effect of most older assumables being gone one way or another, and new loans not allowing for assumption. Still, there are a few of the older assumables still around, and occasionally you'll find them.

What's On the Horizon
Today, however, we see a resurgence in assumable loans both government-backed and private. Essentially all of them are what are known as “qualifying assumables” which mean that the purchaser has to go through some semblance of qualification before taking over the loan. In that pre-1980 era there existed that non-qualifying variety, where all a person had to do was sign their name to take over the note. Those days, unfortunately, are gone. Today, even when you can find an assumable loan, you'll be scrutinized as to your income, debt, credit and so forth. The good new is that qualifying for an assumable loan is generally easier and less thorough than for getting a brand new loan.

What to Look For
Perhaps the best-known assumptions are available with Federal Housing Administation (FHA) loans and Veterans Administration (VA) loans. Currently, FHA loans can be assumed with modest lender approval, but only for owner occupants. Investors may not assume them - but my belief is that will eventually change. VA loans can be assumed by anyone as long as they go through the qualifying process and are approved by the lender. It's also important to note that many conventional lenders (not government-backed) are offering assumable loans once again...of course, expect qualification to be part of the process.

Understand the Benefits of Assumable Loans
The beauty of assuming a loan is that you don't have to pay points, loan origination fees, and junk lender fees to get the loan. Keep in mind that with a brand new loan origination, you could get hit with up to 3% of the loan amount just for various lender fees and requirements. That's a hefty amount to pay in addition to a down payment. With an assumable, you only pay a small (often only a few hundred dollars) assumption fee. You don't even typically pay for an appraisal unless you want one! The bottom line is, it's a relatively easy form of financing to access.

It's All in the Numbers!
What's even more valuable is related to the math behind an existing loan. You are probably aware that in the early days most of your payment goes towards interest, with very little contributing towards the principal payoff. That ratio starts to change around year 7 of a 30-year loan, and by year 15, the principal and interest portions are equal. Past year 15 and the principal portion is the larger amount.

Often people get all hung up on the interest rate of a new loan in the current climate - say, 6.75% versus what's usually a higher rate for an existing assumable loan. Let's say, 8.25%. The untrained eye will alway say the lower rate would be the better deal. That may be the furthest thing from the truth. What if the assumable only had 14 years remaining to pay? With the new loan nearly all of your payment is going to interest (makes the bank fat). With the assumable, more than half is going into your principal paydown (basically the same as putting it in the bank!). And, you don't have 30 years to wait to pay it off -- you only have 14. Run the numbers and you'll find tens of thousands of dollars saved because it was the old loan-holder who paid all of that interest.

So, keep your eyes and ears open for assumability of loans. If you find one, look at the numbers. In most cases you'll find you have stumbled onto a real treasure.