Assumable mortgages could find renewed popularity with low rates

(As seen in the 9/18/20 Ledger column)

As the pandemic continues to infect and kill people, and millions more remain out of work, home sales are at record highs, and the lending world is feeding this by offering interest rates that have never been this low.

Back in 1920, rates were hovering around 4% and have not dipped below that until recently.

Investing in real estate at current interest rates would seem a relatively safe investment. As rates return to normal levels, people will not be able to purchase as much house as they currently own for the same price, since monthly payments will increase proportionately.

As buying ability decreases, selling activity decreases as inventories shrink. If homeowners cannot buy more house, they remain at home, and would perhaps build an addition.

Their loans will be worth as much as their homes. When that happens, rental rates rise, but fixed rates mortgages on investment property remain stable.

In the past, when mortgage rates were significantly higher than they had been in the recent past, assumable loans became popular. For example, if a property had an existing 6% loan and the current rates were 9%, a person would be able to pay the buyer a lump sum and assume the remaining mortgage at the terms set forth with the original purchase.

The buyer had to qualify for the loan in the same manner as the owner had.

Then there were the ever-popular non-qualifying assumable loans, meaning that anyone who could fog a mirror could pay the homeowner and take over the payments.

The benefits to both buyer and seller alike were immense. But the non-qualifying assumable loan will never reappear, or at least it should never make a comeback. Buyers were usually not worthy of credit, and those loans often found their way into foreclosure.

However, as streamlined as the loan process is and as accessible as information is, the qualifying assumable loan might be the answer to what portends to be a real estate disaster in the making.

On his Facebook page, Realtor Grant Hammond noted that a $475,000 mortgage at 2.5% interest allows for a payment of $1,877. The same mortgage at 4% would have a payment of $2,268.

What he did not mention is what would happen if rates hit 8%. In that case, the monthly payments hit $3,485 per month, almost double what they would be in today’s market.

In the world of assumable mortgages, if a seller wanted $575,000 for his home and he had the 2.5% loan, a buyer could pay $100,000 and assume the loan with payments of $1,877, with a few years of the 30-year amortization having been paid by the owner. With a new loan at 8%, there would be a requirement of 20% down, or $115,000 plus closing costs – a cost eliminated in an assumption – and the payments would be based on a loan of $460,000 (sales price, less down payment). That monthly payment would be $3,375.

Given that it could take some time to hit 8%, plug in 5%, a normal rate, and the payment would be $2,469.

To recap, a house sells for $575,000. The loan is $475,000. If a buyer assumes the existing loan, he is out of pocket about $100,000 and his payment is $1,877 per month. If he gets a new loan at 5% on a 30-year mortgage, he needs $115,000 plus closing costs out of pocket, and his payment is $2,469.

In order to get the $1,877 monthly payment with a 5% rate, the buyer would have to invest $250,000, not $100,000.

By the way, the seller would receive the same money either way.

The lenders will need to determine a way to profit on these loans. The market is going to be crying for them.

Richard Courtney is a licensed real estate broker with Fridrich and Clark Realty and can be reached at richard@richardcourtney.com.