Dealing with “The House” just got more complicated with soaring rates and record-breaking property values. If your client (or opposing party) wants to keep the house, the idea of a loan assumption may get floated around.

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 a 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).

Logically, amidst a divorce equity buyout, a loan assumption may seem to be an ideal course of action. Given the fact that there are two Borrowers who are responsible for paying back an existing mortgage loan — and only one of them wants to keep it — why not just allow the in-spouse to keep the existing mortgage instead of being forced to refinance the current loan into a brand-new one? The loan assumption option would also serve to accommodate the out-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 an assumption is better for the consumer — especially 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 — not to mention saving 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. Among the reasons include:

• 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, and typically have verbiage in the promissory note not allowing a loan assumption to be made.
• 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 has two different Guarantors to pursue through legal remedies in the event the debt is not paid as agreed. 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 who are expecting proper business decisions to be made. Why not enforce the existing 2.750% 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 have a client who wants to keep the house, and you think 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. Have your client call their lender to find out if a loan assumption is an option for them. Note: The representative on the phone may tell them 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.

All the best,