Assumption Clause

What Is an Assumption Clause?

An assumption clause is a provision in a mortgage contract that allows the seller of a home to pass responsibility for the existing mortgage to the buyer of the property. In other words, the new homeowner assumes the existing mortgage. The buyer must typically meet credit and other qualifications.

How an Assumption Clause Works

If the interest rate on an existing mortgage is lower than current market rates, an assumption clause becomes an attractive selling point. Also, the buyer can avoid many closing costs, though there are some fees involved in assumptions. Some of the costs will include a title search, document stamps, and taxes.

For most homeowners, the benefits of an assumption clause are theoretical since conventional mortgages generally prohibit the practice. Banks frown on assumption clauses because they write mortgages based on the creditworthiness of the original borrower, not an unknown later buyer.

The new owner's ability to repay may be challenging to evaluate, and the bank may be reluctant to take on their risk. Moreover, even if a bank were to approve the creditworthiness of a new borrower, it would lose out on the down payment and closing costs incurred with a brand-new mortgage.

Special Considerations

As it is rarely in a bank’s interest to allow assumptions, most mortgages include a due-on-sale clause, which demands repayment of the remaining balance when the property sells. The bank will sign off on its lien until the mortgage paid, making the sale impossible.

However, assumption clauses are standard in government-backed mortgages from the Federal Housing Administration (FHA), the Veterans Administration (VA), and the U.S. Department of Agriculture (USDA). The new owner must still meet credit and eligibility standards.

Assumption Clause Example

Imagine a person who wants to assume the mortgage from a seller who has a 30-year, $240,000 mortgage at 3.5%, on which they have made payments for five years. The remaining balance, including interest, is about $323,300, and 25 years are remaining on the original note.

Assuming the current market interest rate is 4%, the new buyer taken out a 30-year fixed-rate mortgage for the same $240,000 loan, it would make the balance, with interest, due at the end of that time of about $412,500. Also, the new buyer would need to submit a lump-sum down payment to the financing institution.

By assuming the seller’s existing mortgage, the buyer would save about $89,000 over the term of the loan. Also, there are five fewer years of payment obligation with the assumption-clause loan. Any lump-sum payment would be given to the seller to offset the equity they have built up in the home. Plus, the buyer will avoid thousands of dollars in closing costs.