Mark Fowler, chief revenue officer and vice president of production for Residential Finance Corp. in Charlotte, says he and his wife will use FHA financing to purchase their home even though they are making a down payment of more than 20 percent and could easily qualify for conventional financing.
An assumable loan is a mortgage that the seller transfers to the buyer without any change to the loan terms or interest rate. Buyers save on both the lower interest rate and lender fees, says Paul Defngin, a senior mortgage banker with Apex Home Loans in Rockville, Md.
"Conventional wisdom says that we're near the bottom for interest rates and that most people stay in their homes for five to seven years," says Fowler. "If you think interest rates in five to seven years will be six percent or higher, then offering buyers at that time an assumable FHA loan at, say, 3.39 percent should be a big selling point. It's conceivable to get a $25,000 premium on the sales price depending on how high interest rates are at that time."
Here's how it worksFHA loans are fully assumable, but buyers must qualify for the loan according to FHA and lender guidelines, says Sue Pullen, regional vice president for Fairway Independent Mortgage in Tucson, Ariz. Borrowers would need to provide full documentation of their income and assets and have a high enough credit score and low enough debt-to-income ratio to qualify for a regular FHA loan.
Let's say the original mortgage was for $300,000 and the balance is down to $200,000 when you've decided to sell. The buyer assumes the remaining balance on your loan and must come up with $100,000 in cash to reach the original loan balance.
To come up with that difference, buyers can either apply for a second loan or ask the seller to finance the balance, says Joe Buxton, vice president of sales for Residential Finance Corp. in Columbus, Ohio.
For example, Buxton says, the seller could offer an assumable loan with a balance of $200,000 at 3.5 percent and finance the additional $100,000 at 8 percent if mortgage rates are around 6 percent. If that's the case, the buyer would benefit because the average interest rate on the two loans would be 5.75 percent, below the market rate of 6 percent.
Timing is keyTiming is key when offering an assumable loan, says Defngin.
"The sweet spot is probably right around five to seven years, because if you wait longer, the balance of the loan will have been paid down and the home value may have risen so that the loan you're offering will cover very little of the sale. Offering an assumable loan could be a relatively small advantage to the seller if the gap between the loan balance and the sales price is large."
Disadvantages of FHA loansRecent changes have caused the price of FHA mortgages to increase. As of April 1, 2013, mortgage insurance premiums have risen, and as of June 3, 2013, FHA borrowers are required to pay mortgage insurance for the life of the mortgage if they make a down payment under 10 percent, says Defngin. "Even if you make a down payment of 10 percent or more, you have to pay mortgage insurance for at least 11 years."
"Right now mortgage insurance premiums are tax deductible, which helps, but if you have good credit and can make a down payment of 5 percent or more, it usually makes more sense to take out a conventional loan," says Pullen. "On a conventional loan, you can often pay the mortgage insurance upfront and save $200 or $300 a month in extra payments."
Pullen continues, "The fact that FHA loans are assumable is a nice side benefit for someone who is already planning to use FHA financing, but I don't think that's enough of an incentive to choose FHA over conventional."
Be sure you calculate both the short- and long-term cost of an FHA loan versus a conventional loan before making your mortgage choice.
About the author:
Michele Lerner, author of "HOMEBUYING: Tough Times, First Time, Any Time", has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT's REIT magazine and numerous Realtor associations.