Options to Avoid Foreclosure: Loan Assumption
If you’re behind on your mortgage payments and considering transferring the deed of your home to a new owner, a loan assumption might be an option to avoid foreclosure. In a loan assumption, the new owner takes over the mortgage debt and becomes responsible for the payments.
Inheriting or Acquiring Property
If you inherit a mortgaged property or obtain ownership through a divorce or other family transfer but can’t afford the payments, assuming the loan through a modification might help you keep the property.
Understanding Promissory Notes and Mortgages
Before understanding loan assumptions, you need to know the difference between a promissory note and a mortgage (or deed of trust, which is similar for this context).
Many people use “mortgage” to refer to both the promissory note and the mortgage, but they are different. The note creates the obligation to repay the loan, while the mortgage gives the lender a way to enforce repayment, often through foreclosure if necessary. After foreclosure, lenders can pursue the borrower for any deficiency between the sale price and the total debt.
What Does It Mean to Assume a Loan?
An assumption is when a new person takes over financial liability for a loan, with or without releasing the original borrower’s liability. If you sell your home and the new owner takes over the loan, they must usually qualify through an approval process, including a credit check and income verification. Once approved, the new owner makes the monthly payments under the existing loan terms. The original borrower remains liable unless released by the lender.
Borrower Liability Following an Assumption
In some cases, the lender releases the original borrower from the obligation, but not always. Depending on state law and circumstances, if the new owner defaults, the lender might pursue both the original borrower and the new owner for the deficiency.
Determining If Your Loan Is Assumable
Not all loans are assumable. FHA, VA, or USDA-backed loans may be assumable if certain conditions are met. Check your loan documents for an assumable clause. If it’s silent, the loan might still be assumable in most states.
Due-On-Sale Clauses
Many mortgage contracts include a “due-on-sale” clause, which requires full repayment of the loan if the property is transferred to a new owner. If your loan has this clause, it generally can’t be assumed.
Exceptions to Due-On-Sale Clauses
The federal Garn-St. Germain Depository Institutions Act of 1982 generally allows due-on-sale clauses in mortgage contracts. But the Garn-St. Germain Act bars enforcement of a due-on-sale clause after some kinds of property transfers, including, but not limited to:
- A transfer by will, inheritance, or legal operation of law following the death of a joint tenant or tenant by the entirety.
- A transfer due to the borrower’s death to a relative who will live in the property.
- A transfer to the borrower’s spouse or children who will live in the property.
- A transfer resulting from a divorce decree, legal separation agreement, or property settlement agreement, where the new owner will live in the property. (12 U.S.C. § 1701j-3, 12 C.F.R. § 191.5).
If you acquire real estate ownership through one of these transactions, the lender cannot enforce a due-on-sale clause. You can make the loan payments even if you were not the original borrower, and you have the option to assume the debt. (Note that the Garn-St Germain Act allowed states with existing laws on due-on-sale clauses three years to reenact or create new restrictions. Only a few states did so within this period, meaning federal law generally overrides due-on-sale provisions for certain loans in most states.)
Additionally, following a Garn-exempt transfer, the ability-to-pay rule does not apply. The person assuming the loan typically does not need to go through an underwriting process or credit screening, except in some cases, such as with a Fannie Mae loan, where the original borrower seeks a release of liability.
Servicer Compliance with Federal Laws
If you acquire property through a Garn-exempt transfer and can’t afford the payments, federal law requires the servicer to let you apply for loss mitigation and consider all options, even without formally assuming the loan.
Voluntary Non-Enforcement of Due-On-Sale Clauses
Sometimes, lenders might not enforce the due-on-sale clause if it ensures a steady stream of payments or if the property’s market value is less than the loan balance and the purchaser can make up the difference.
Assuming a Loan in Default
If the loan is in default at the time of transfer, the new owner might need to pay the overdue amount in full or work out a repayment plan to prevent foreclosure.
Seeking Help
Assumption is one way to avoid foreclosure. If you’re struggling with mortgage payments, facing an underwater home, or imminent foreclosure, consider consulting a foreclosure attorney or a HUD-approved housing counselor to explore your options.