Assuming a Loan Can Prove Beneficial to Buyers, Sellers

Conventional wisdom teaches us to never make assumptions. When it comes to purchasing a home, however, assuming a loan can be of benefit both to buyers and sellers.

Virtually all adjustable-rate loans today are assumable by a second home buyer. One of the best aspects of fixed-interest rate Federal Housing Administration and Veterans Administration loans is that they are assumable--sometimes for no money down. Commercial mortgage lenders are also allowing some loans to be assumed by a new buyer if the original borrower can’t make the payments any more. These distress situations help sellers extricate themselves from a tough situation and new buyers can get into a house with lower income qualifications.

The ability of buyers to assume FHA and VA loans makes homes with these loans easier to sell, said Richard Montano, a senior processor at mortgage broker Tower Funding of Valencia Inc. FHA- and VA-financed properties can be assumed repeatedly by a new borrower, who may be able to get into these homes with essentially no money down. (The VA loans, however, are only restricted to veterans.) Lenders may charge several hundred dollars for processing when an FHA or VA loan is assumed, Montano said. But “there are no other fixed-rate loans that we know of that are assumable,” he said.

Whether a loan is assumable depends on what’s known as a “due-on-sale” clause in a deed of trust and in a promissory note. Most mortgage loans have a clause that says the loan balance is due when the property is sold. Loans without a due-on-sale clause can generally be assumed--although most lenders include requirements in their loans for qualifying the new borrower and collecting a fee for approving the loan assumption.

Many mortgage lenders are allowing loans with a due-on-sale clause to be assumed by a new buyer today--especially where the current owner is in financial distress, said Marta Richardson, a loan service account manager for General Electric Mortgage Insurance Corp. in Orange. Because of the decline in value of Southern California real estate this decade, in many situations, there is no equity in a home and the current owner can’t make the loan payments, she said, so lenders frequently allow the mortgage to be assumed as a way to avoid having to foreclose on the property.

“As long as the buyer is stronger than the current owner, there is a good chance the lender will let the loan be assumed,” Richardson said. For this to happen, it would have to be approved by the owner of the loan, the loan servicer and the mortgage insurer--if there is one.

Despite all the parties that need to sign off on such an assumption, Richardson said, the mortgage guidelines are much softer than usual. Home buyers who want to assume a delinquent loan frequently don’t have to come up with any down payment and they may be able to qualify for loan assumption even if their housing expenses would exceed the usual ratios that lenders look for when deciding whether to approve a loan.

“This is a way for people who can’t otherwise qualify to buy a home,” Richardson said. But just because somebody assumes a distressed mortgage doesn’t mean that the original borrower is off the hook. If the new borrower makes steady payments for 18 to 24 months, she added, the old borrower will usually be removed from any responsibility for the loan.

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Also coming back into vogue is a Byzantine financing arrangement called the all-inclusive trust deed, said Ann Carlton Bose, president of Estate Funding Inc. in Woodland Hills and a past president of the California Assn. of Mortgage Brokers, Los Angeles chapter. An AITD--also known as a wrap-around mortgage--is basically a second mortgage made by a seller.

The seller typically collects a payment from the buyer and then uses that payment to make a payment on the seller’s own first mortgage. The seller remains obligated on the first loan, but the seller can make the AITD a profitable venture by, for example, paying 8% interest on the first loan and charging 9% on the new loan to the buyer.

However, AITDs are often not legal because they violate a provision of the original loan, Bose warned. In fact, AITDs are often done without notifying the lender on the first mortgage--the original borrower keeps making payments on the first to keep the lender from finding out that the property has been transferred. And that is usually fraudulent.

“You have to read your loan documents carefully,” Bose said.