Assumable Mortgage – Definition & Explanation

Cite this article as:"Assumable Mortgage – Definition & Explanation," in The Business Professor, updated March 7, 2020, last accessed August 6, 2020, https://thebusinessprofessor.com/lesson/assumable-mortgage-definition/.

Back to: BANKING, LENDING, & CREDIT INDUSTRY

Assumable Mortgage Definition

An assumable mortgage is a method of financing that allows the transfer of an existing mortgage and its terms from the initial borrower to the subsequent buyer.

A Little More on What is an Assumable Mortgage

An assumable mortgage is one of the many ways through which homebuyers finance the purchase of a property. Ordinarily, most homebuyers approach a lending institution to obtain a mortgage which allows them to purchase a home.

There are specific terms contained in the loan agreement, such as the principal amount, interest rate, repayment schedule, security interest attachment, and others.

If the homeowner decides to sell the property in the future but still has some outstanding mortgage loan to pay back, the assumable mortgage allows her to transfer the mortgage and all the terms to the subsequent homebuyer.

Even More of an Explanation of an Assumable Mortgage

There are two types of mortgage loans that are assumable,  Federal Housing Administration (FHA) loans and the Veterans Affairs (VA) loans. Other categories of loans such as conventional loans are not assumable.

The subsequent homeowner must specifically assume the outstanding debt.

It is important to know that the transfer of the mortgage is subject to the approval of the mortgage lender. The original loan agreement will specify the requirements that a homebuyer must meet before the assumable mortgage can be approved by the original lender.

If an assumable mortgage bid is not approved by a lender, the seller may be able to identify another buyer who will meet the requirements of the lender.

An assumable mortgage provides numerous benefits. It saves time and effort in securing a new mortgage. It may allow the subsequent purchaser to assume a mortgage with more favorable terms than they could secure in a new loan.

There are specific conditions that determine the cost and benefits of an assumable mortgage. The first is the existing balance of the mortgage. For instance, if the homeowner or seller of a property has an existing balance of $200,000 and the home to be purchased is $350,000, it means the buyer will make a down payment of $150,000 to make up the difference between the balance and home value. Another option would be for the new purchaser to take a second mortgage to cover the difference in value and purchase price.

Academics research on “Assumable Mortgage”

Modeling conventional residential mortgage refinancings, Giliberto, S. M., & Thibodeau, T. G. (1989). Modeling conventional residential mortgage refinancings. The Journal of Real Estate Finance and Economics2(4), 285-299. This article models fixed-rate mortgage refinancings and offers an empirical test of the model. The model relates the probability that a household prepays its residential mortgage to both financial and economic variables. The financial variables included in the model measure the value of the embedded call option present in conventional fixed-rate mortgage loans. The economic variables measure the household’s propensity to prepay for housing consumption adjustment reasons. Our main empirical finding is that increased interst-rate volatility significantly decreases prepayment probability. In addition, we find some statistical evidence to support the hypothesis that prepayment rates increase with increases in household income, increases in household size, and vary by age of household head and regionally.

Assumable Loan Value in Creative Financing, Ferreira, E. J., & Sirmans, G. S. (1984). Assumable Loan Value in Creative Financing. Housing Fin. Rev.3, 139.

The Economics of Mortgage Terminations: Implications for Mortgage Lenders and Mortgage Terms, Hendershott, P. H., Hu, S., & Villani, K. E. (1983). The Economics of Mortgage Terminations: Implications for Mortgage Lenders and Mortgage Terms. Housing Fin. Rev.2, 127.

An Analysis of the Ex Ante Probabilities of Mortgage Prepayment and Default, Yang, T. T., Buist, H., & Megbolugbe, I. F. (1998). An analysis of the ex ante probabilities of mortgage prepayment and default. Real Estate Economics26(4), 651-676. Observed mortgage prepayment and default rates have been far different than the ruthless option exercise rates predicted by contingent claims models of mortgage pricing. The discrepancies have been attributed to both the competing‐risk nature of prepayment and default and to transactions costs. This paper tries a different means of reconciliation. We introduce a third stochastic process, household income, into the usual pricing model that includes only the spot interest rate and the house price. The presence of income allows considering consumption‐theoretic determinants of termination. The role of mortgage underwriting rules in restricting optimal prepayment is also explicitly modeled. Numerical ex ante prepayment and default rates based on the theoretical model come much closer to historical experience.

Consumer Default of Delinquent Adjustable‐Rate Mortgage Loans, Weagley, R. O. (1988). Consumer Default of Delinquent AdjustableRate Mortgage Loans. Journal of consumer affairs22(1), 38-54. An examination of the default behavior of delinquent Canadian rollover mortgage borrowers suggests that borrower ability‐to‐pay considerations are relevant to the default decision. They are, however, secondary to housing equity considerations. Results from both ratio and linear‐additive specifications suggest that a ratio specification conceals the independent effect of income and wealth variables.

Was this article helpful?