Mortgages
The Assumption and Second Mortgages
By
Feb 22, 2006, 11:19

The Assumption

Many existing mortgages are at rates below those on new mortgages. If interest rates are 12 percent, but the owner of the property you are trying to buy has an 8 percent loan, you are better off assuming his loan. It used to be easy for a buyer to assume such a mortgage simply by paying the seller a sum equal to his equity and by taking over the payments. Lenders have tried to stop this practice by enforcing the due-on-sale clause. This clause calls for a full payment of the loan when the property is sold. As contract sales and assumptions climb, some lenders have begun to crack down, insisting on a higher interest rate on assumed mortgages or the full payment of the loan. They threaten foreclosure if borrowers don't cooperate, although few cases have gone that far. Sellers contend that if lenders made an 8 percent loan for 30 years the institutions should be willing to live with that rate, no matter who owns the house. Lenders, however, insist that contractual rights are not as­signable. They will honor their agreement as long as that individual has the title. But they didn't price that product for 30 years for other parties, whose credit may be less desirable than the seller's.

Some banks allow a buyer to assume a mortgage containing a due-on-sale clause if the buyer pays a prevailing mortgage interest rate or possibly a rate slightly below it. While that may save some of the closing costs associated with taking out a new mortgage, it doesn't provide the benefits of an outright assumption. Few savings and loan or banks will write loan agreements that allow a new buyer to assume the existing property loan. However, many in­surance company loans are assumable at the original rate. Court decisions or state laws may prevent lenders from enforcing due-on-sale clauses. In those states, buyers may be able to enforce their right to assume a mortgage. Ask your attorney about this.

One way to avoid due-on-sale is to assume a home loan backed by the government. All FHA and VA insured loans are assumable. Most conven­tional mortgages that were taken out before the 1970s can also be assumed. But the problem with these loans is that the value of most of those homes has increased so much that the amount that can be assumed is a fraction of what needs to be financed. The loan is small in relation to the property's market value, both because the loan has been paid down by the owner and because the value of the property has risen due to inflation. This leaves a gap that your down payment won't fill. Therefore, you should try to assume the seller's mortgage but also ask him to accept a second mortgage or second trust deed secured by the property as part of the down payment.

Second Mortgages

The need for a second mortgage arises when there isn't enough cash to cover the difference between the purchase price and the mortgage loan amount. Sellers often become a source for second mortgages so that the deal won't fall apart for want of a relatively small amount of money. (However, second mort­gages can be written for any amount, as long as it's covered by the value of the property.) The terms, including the interest rate, are based on the buyer/ seller agreement. It's often a short-term loan. Sometimes only interest is paid until the term date, when the balance is due. A buyer then can pay off the loan or refinance. For example, suppose a house sells for $100,000. The buyer makes a $20,000 down payment and takes over the seller's mortgage, which has an unpaid balance of $40,000. The buyer still needs another $40,000. So the seller grants the buyer a loan for that amount. If this loan is secured by a deed of trust, it's called a second deed of trust. If the interest rate on the existing mortgage is low, the buyer's combined payments to the bank and to the seller may be lower than if he borrowed the entire $80,000 from a bank. Second mortgages are well suited for the buyer with a small amount of cash for a down payment, but with a monthly income high enough to handle both mortgages.

Many lenders, however, won't allow a second mortgage. In an effort to conceal the second mortgage from the primary lender, most seconds aren't recorded until after closing. Also, the seller holding the second mortgage can be financially grounded if the buyer doesn't make payments on the first mort­gage. A foreclosure on the first loan would wipe out money owed by the buyer on the second mortgage, because it's a secondary obligation. Only after that loan is satisfied and the mortgage retired can a lien that has a position junior to the first move up the ladder and become a first mortgage. For this reason, a lender making a second mortgage will want a higher interest rate and will usually offer less money for a shorter period of time.