Should you Consider a Loan Assumption?
If you’re in a divorce process or considering it, one of the most challenging issues is dealing with the house. The house is the biggest financial asset and obligation in most divorces. It’s not something that can be taken lightly. With soaring rates and record-breaking property values, it’s only becoming more challenging. If you are going through divorce mediation, you may want to look at a loan assumption.
What is a Loan Assumption?
One option that often emerges to resolve the house is the idea of a loan assumption. That means one party taking over the loan of another. However, it’s not that simple. I wanted to clarify a few things about loan assumptions because they can often be misunderstood. A loan assumption is not a refinance, a loan modification, or forbearance. A loan assumption is something altogether different. It allows an existing mortgage loan contract to be taken over (aka assumed) by either an existing Borrower or a brand-new Borrower without modifying the remaining loan term, interest rate, payment amount, or loan amount.
Example:
- Loan Balance: $358,275
- Years Remaining: 17
- Interest Rate: 2.750%
Assuming that loan would mean taking over the $358,275 balance, for 17 years, at 2.750% interest rate. A loan assumption does not provide for any cash out (such as in a buy-out).
The case for a loan assumption
Logically, amidst a divorce equity buyout, a loan assumption may seem to be an ideal course of action. There are two Borrowers who are responsible for paying back an existing mortgage loan. Only one of them wants to keep it. Why not just allow the spouse living in the house to keep the existing mortgage? Instead, the Lender forces the Borrower to refinance the current loan into a brand-new one. The loan assumption option would also serve to accommodate the other spouse by alleviating him/her of responsibility to pay the existing mortgage debt as they relinquish the occupancy and ownership of the marital home that secures this loan.
Furthermore, a case could be made that a loan assumption is better for the consumer. This would be true if the current note has been contractually agreed for the Borrower to pay the Lender back at a low fixed rate (example: 2.750%). and current market rates are at 5.750%, for example. The divorcing couple could also save on the acquisition costs of procuring a new mortgage loan.
While this option seems like a win/win for divorcing homeowners, it is not safe to presume the bank will allow any Borrower to assume the existing mortgage.
Reasons why a bank may not allow a loan assumption:
Contractual Terms:
The majority of mortgage loans throughout the country are classified as “Conforming” (aka “Conventional”). These loans “conform” to the guidelines of Fannie Mae & Freddie Mac. They typically have verbiage in the promissory note not allowing loan assumptions
Leverage:
The existing contract has two different Guarantors (Borrowers) responsible for repayment of this debt. We likely won’t see promissory notes with an out-clause for one Guarantor due to a failed marriage. The Lender currently may pursue two different Guarantors through legal remedies. What is the incentive for the Lender to let one off the hook?
Market Conditions:
Referencing the above example, what financial incentive does the lender have to allow a 2.750% debt to remain intact when the current market can fetch a 5.750% return? The lender has shareholders. The shareholders expect lenders to make proper business decisions. Lenders may prefer to enforce the existing 2.750% to be paid in full (through the sale of the marital home, or a refinance). By pursuing this option, the lender can free up that loan amount, and then presumably lend that amount of money to someone else at the 5.750% rate, while generating revenue for originating a new mortgage loan.
It bears noting that Federal Housing Administration (FHA) and Veterans Affairs (VA) typically do allow loan assumptions. That said, the assuming Borrower still must qualify for this assumption after their ability to repay the debt and program eligibility have been analyzed thoroughly. So if you think that you want to keep the house and that a loan assumption might
be an option, best practice is to:
1. Read through the original loan documents to verify the specific terms of their particular loan.
2. Call your lender to find out if a loan assumption is an option for you.
Note: The representative on the phone may tell you to apply, which can be a boiler-plate scripted response to their inquiry. That should not be confused with an affirmative verification that their loan is assumable.
As always, please feel free to reach out to me with any questions about the real property matters in your case.
Harold Deblander
Certified Divorce Real Estate Expert
Sotheby’s International Realty
414-937-8962
[email protected]