Assuming a Loan versus Getting a New Loan

If you are buying a home that has an assumable mortgage, here are some questions to ask:

• Will the lender charge an assumption fee? How much?

• What is the outstanding balance of the old loan? Is it large enough? How much cash will I need?

• If it is not large enough, will the seller be willing to take back a second mortgage?

• What are the rates and costs of a second mortgage? From the seller? From a lender?

• Would the combined monthly payments and interest of the old mortgage plus a new second mortgage be more or less than those of a new first mortgage?

There is no simple formula or rule of thumb to help decide whether or not to assume an old loan. However, the following example shows how an assumption can be much better than a new loan.

Example: Mr. and Mrs. Homebuyer are purchasing a $125,000 home, and they have $30,000 in cash to cover the down payment ($25,000) and closing costs (about $2,000, plus points). They have the option of assuming an existing loan with a balance of $73,000 or getting a new first mortgage.

Option 1: Assume Old Loan

Old first mortgage:

• $85,000 original balance, $73,000 remaining balance

• 7-percent first mortgage with one-point assumption fee

• 20 years remaining on 30-year term

• Monthly principal and interest payment: $565.61

FIGURE 6.2 Assumption versus New Mortgage

Assumption versus New Mortgage

New second mortgage:

• $25,000 at 10 percent, fixed-rate plus one point

• 15-year term

• Monthly principal and interest payment: $268.65

Option 2: Get New Loan

New first mortgage:

• $100,000 at 8 percent, fixed-rate plus three points

• 30-year term

• Monthly principal and interest payment: $733.76

By assuming the existing loan, Mr. and Mrs. Homebuyer would save $2,000 in points. The assumption fee is one point ($730), and the second mortgage lender charges one point ($250) for a total of $980, versus $3,000 in points for a new first mortgage. The monthly

FIGURE 6.3 Comparison of Monthly Payments and Total Payments

Comparison of Monthly Payments and Total Payments

payments for assuming the old loan are $100 per month higher. But because the interest rate on the old mortgage is only 7 percent, the interest charges are $80 per month lower. More of the payments are going toward principal and less toward interest. By paying just 15 percent or $100 per month more in their monthly payments, Mr. and Mrs. Homebuyer would pay off their mortgage faster and save more than $80,000. (See Figure 6.3.)

Option 1: $565.61 × 230 months + $268.65 × 180 months = $184,079

Option 2: $733.76 × 360 months = $264,153

In this example, assuming the old loan would be far better than getting a new mortgage.

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