What are assumable mortgages?
With interest rates on the rise, more and more homeowners and first-time buyers are looking to save money. In this context, buying a property by "assumption" may seem like a good solution. But is it?
The concept is not new. However, in the current economic climate, it’s becoming increasingly popular.
Are you thinking about transferring your mortgage? Beware: mortgage transfer comes with its own set of risks! It's best to understand them before you sign the purchase agreement.
What is mortgage assumption? Definition.
A mortgage assumption, also known as an assumption agreement, is simply becoming responsible for another person's mortgage. In this way, you retain the terms and conditions negotiated by the seller, especially those related to the mortgage rate.
In other words, an assumption is a legal act that allows a buyer to assume a seller's mortgage rather than having to take out a new loan. When included in the purchase offer and accepted by the creditor, the buyer becomes responsible for the mortgage to the said lender.
Notaries also use the term "delegation of payment" to refer to this process, as mentioned in Article 1667 of the Civil Code of Quebec.
Example of an assumable loan
To make things clearer, here's an example of a mortgage assumption:
Peter owns a house. In 2021, he took out a mortgage for 5 years at 3.25%. Two years later, in 2023, he decided to sell his house. The balance of his mortgage is now $350,000.
Mary thinks the current mortgage rate of 6.19% is too high. She suggests that Peter purchase his home by assumption for $475,000. She will then assume the mortgage ($350,000) with the financial institution and can take advantage of the terms and rate (3.25%) associated with it for the remainder of the term. She will also pay Peter the difference of $125,000.
After the sale, Mary will make the payments to Peter's lender.
The benefits of assuming a mortgage
Some buyers and sellers are tempted to assume a mortgage because the assumption agreement offers them several advantages, particularly in terms of interest rates and out-of-pocket expenses.
1. Lower interest rates
For a buyer, the main advantage of a transfer is undoubtedly the fact of benefiting from the interest rate previously obtained by the seller, when it is lower than the current rates. This can make a real difference to your wallet!
Let's return to the previous example:
Mary would pay $2,279 per month if she took out a new loan at 6.19%. However, by assuming, she can take advantage of Peter's 3.25% rate for the remaining 3 years of the term. She would then pay $1,701 per month, a savings of $20,000 over three years.
2. Avoid certain costs
Signing an assumption agreement also reduces certain costs associated with the real estate transaction, for both the buyer and the seller. For example, the seller will not have to pay a prepayment penalty, and notary fees will be reduced.
The risks of a mortgage assumption
The reason why the assumption agreement is so controversial, despite the advantages mentioned above, is that the process involves several financial risks. This applies to both the buyer and the seller.
1. Remaining responsible for the loan
The main disadvantage of mortgage assumption concerns the seller, who remains liable for the mortgage even though he no longer owns the house. This means that he remains the guarantor of the mortgage, even after the extension period, until the mortgage is discharged.
If the buyer stops making payments, even several years after the mortgage has been assumed, the bank could sue the seller to recover what it is owed.
In addition, the seller remains liable for the loan even if the house is sold several times in subsequent years. As long as the property is resold with the assumed mortgage and the bank that made the loan does not release it, the liability continues.
As a result, if you are the 4th owner to purchase the home by assumption, you and the 3 previous owners are all at risk of having the home repossessed in the event of non-payment. Until the mortgage release papers are properly signed.
2. Reducing the borrowing capacity
As with a standard purchase, the buyer's borrowing capacity will be affected by the assumption of a mortgage. Depending on your financial situation, you may find it difficult to obtain other loans (such as a car loan) or forms of credit.
However, the seller's ability to borrow will also be affected, as his creditors will take into account that he remains responsible for this mortgage debt. If he tries to get another mortgage to buy a new home, his application could be rejected.
The existence of an outstanding mortgage could adversely affect his credit rating, reduce his borrowing capacity and prevent him from realizing his financial projects.
How to mitigate risk
Obviously, the best way to avoid the risks associated with assuming a mortgage is not to get involved in an assumption sale. However, if you are still interested in this type of transaction, here are some precautions to take:
- The seller can ask their lender to write a letter releasing them from any responsibility for the debt once the sale is complete. This document should be kept carefully until the property is paid off in full.
- The seller can also ask to include a clause requiring the new buyer to obtain a release if they resell the property.
Note, however, that these stipulations do not fully protect the seller during the assumption period, nor do they replace a proper release at the time of sale.
Divorce: assuming your spouse's mortgage to keep your home
Did you know that mortgage assumption can occur in the specific context of a separation or divorce? In fact, it's one of three options available to spouses to divide property between them.
If the couple wants to avoid selling the home and paying penalties, the spouse who does not want to keep the home can sign an assumption agreement. However, the names of both spouses remain on the mortgage contract, as in the case of a standard assumption. So the risks are still very real.
How does taking over a mortgage work?
If you decide to purchase a home by assumption, you'll need to:
- Indicate in your offer to purchase that you wish to assume the seller's mortgage.
- Obtain approval from the seller's financial institution, as all mortgage deeds stipulate that the loan is not transferable without prior approval.
- Prove that you can assume the seller's mortgage. Proof of sufficient income, employment and good credit history will be required.
- Wait for the financial institution to provide the notary with a transfer authorization letter and the financial details of the loan so that the notary can prepare the sale contract.
- Sign the deed of sale.
Note that certain types of mortgages, such as subsidiary or collateral mortgages, may be difficult, if not impossible, to transfer by assumption.
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