Can a Conventional Loan Be Assumed?
Can you assume a conventional mortgage? Understand the general rule, the underlying reasons, and the very rare exceptions.
A loan assumption involves one party taking over the existing mortgage of another, stepping into the original borrower’s responsibilities for the remaining balance, interest rate, and terms. This can be an attractive option, particularly if the existing loan carries a lower interest rate than what is currently available in the market. However, when considering conventional loans, which are not backed by government agencies, the general answer to whether they can be assumed is no. Most conventional mortgage contracts include specific provisions that prevent such transfers. This article will explain why conventional loans are generally not assumable, explore the limited circumstances under which an assumption might occur, and detail the process and consequences for both the original and new borrowers.
Understanding the Due-on-Sale Clause
A significant reason conventional loans are not assumable centers on a contractual provision known as the “due-on-sale” clause, also referred to as an alienation clause. This clause is a standard component in nearly all conventional mortgage agreements. Its primary function is to protect the lender’s interests by requiring the full outstanding loan balance to be paid immediately if the property is sold or transferred to a new owner.
Lenders include this clause to manage risk. Mortgage loans are underwritten based on the original borrower’s financial profile. Without this clause, the loan could transfer to a new party whose financial standing has not been vetted, introducing unforeseen risk. The clause ensures the lender maintains control over who holds the debt.
When a property with a conventional mortgage containing a due-on-sale clause is sold, the clause is triggered, making the entire loan balance immediately due. This mechanism prevents the buyer from simply taking over the seller’s existing mortgage. Instead, the seller must use the proceeds from the sale to pay off the mortgage, or the buyer must secure new financing. This is a fundamental difference compared to certain government-backed loans, which often lack this clause and are generally designed to be assumable under specific conditions.
Scenarios for Conventional Loan Assumption
While the due-on-sale clause makes conventional loan assumptions rare, there are very specific and limited scenarios where such a transfer might theoretically occur. Certain older conventional loans, particularly those originated before the widespread enforcement of due-on-sale clauses through the Garn-St. Germain Depository Institutions Act of 1982, might be assumable. This federal legislation formalized the legality of due-on-sale clauses for mortgages. Additionally, some portfolio loans, which are mortgages held directly by the original lender rather than being sold on the secondary market, may have more flexible assumption policies.
Federal law outlines specific exceptions where a due-on-sale clause cannot be enforced, even for conventional loans. These include transfers resulting from divorce or legal separation, inheritance where a relative becomes the owner, or transfers into a living trust where the borrower remains a beneficiary and the occupancy rights do not change. In these instances, the lender cannot demand immediate repayment solely because of the change in ownership, allowing the existing loan terms to continue.
Unlike conventional loans, government-backed loans (FHA, VA, USDA) are generally assumable, provided certain criteria are met. This difference highlights why conventional loan assumptions are rare exceptions rather than a standard feature.
The Assumption Process
Should a conventional loan be deemed assumable under one of the rare exceptions, the process for the new borrower is comparable to applying for a new mortgage. The potential new borrower must apply directly to the original lender who holds the existing mortgage. This application involves a comprehensive review of the new borrower’s financial qualifications.
The lender will evaluate the applicant’s creditworthiness, income, and debt-to-income ratio to ensure they can comfortably manage the mortgage payments and meet eligibility criteria. The process can take time, often ranging from 45 to 90 days to complete, which is sometimes longer than a traditional mortgage closing.
During this process, the new borrower may encounter various fees associated with the assumption. These can include an assumption fee, which typically ranges from 0.05% to 1% of the original loan amount, appraisal fees, and other closing costs similar to those incurred with a new loan. The lender’s approval is paramount; without it, the assumption cannot proceed formally.
Impact on Original and New Borrowers
In the infrequent event of a conventional loan assumption, the outcomes for both the original borrower (seller) and the new borrower (buyer) are well-defined. For the new borrower, assuming the loan means taking over the existing mortgage’s terms, including the remaining principal balance, the original interest rate, and the established payment schedule. A significant advantage for the new borrower can be securing a lower interest rate if the original loan was originated when rates were more favorable than current market conditions.
However, the new borrower typically needs to pay the original homeowner the difference between the property’s sale price and the remaining loan balance. This amount, representing the seller’s equity, often needs to be paid as a lump sum or through separate financing. This can result in a substantial upfront payment, sometimes larger than a typical down payment for a new loan.
For the original borrower, the transfer of liability is a critical consideration. Unless a formal “novation” or a specific release of liability is granted by the lender, the original borrower may remain secondarily liable for the debt. This means if the new borrower defaults on payments, the original borrower could still be held responsible by the lender. Obtaining a full release of liability through novation, which completely substitutes the original borrower with the new one under the existing contract, requires the lender’s explicit consent and is often difficult to secure. Therefore, without a clear release, the original borrower’s credit could be negatively affected by the new borrower’s payment failures.