What to Assume About Loan Assumptions

Posted on Feb 16, 2023 by Scott MacPherson

As interest rates remain high, one option for investors seeking multifamily financing for acquisitions is a loan assumption. A loan assumption occurs when a real estate buyer purchases a property and takes over a seller’s existing mortgage loan through the lender.  Many types of commercial loans can be assumed, including most Fannie Mae, Freddie Mac, HUD multifamily, and commercial mortgage-backed securities (“CMBS”).

A loan assumption has many benefits for the seller and buyer. The seller is able to exit the loan earlier; avoid prepayment penalties or premiums, and, in some cases, also avoid deadlines for repairs and other items that the seller knows they can’t meet.

Buyer benefits may include lower interest rates than current market rates and reduced closing costs compared to a newly originated loan. Additionally, the buyer is given a clear understanding of the expectations under the loan, as the principal loan balance, interest rate, maturity date, and other loan terms will likely remain the same after the assumption.

One downside for the buyer, is payment of an assumption fee. The assumption fee usually falls somewhere between 0.5 to 1.0% of the original loan amount.  Another drawback, is the evaluation process by lender.  The buyer will have to meet lender’s rigid financial requirements, proving that the buyer is not a financial risk; meets the creditworthiness of the original borrower(seller); and will be able to make the payments required under the loan. The approval process is comprehensive, looking into the buyer’s multifamily experience, financial strength, contingent liabilities, cash equity, and credit history and may take up to 90 days.  The lender’s goal is to confirm that the borrower is a solid candidate and worth lender foregoing the considerable fees associated with originating a new loan rather than approving an assumption.

In evaluating the buyer, a lender will request up to three years of tax returns; personal financial statements showing both assets and liabilities; and other proof of buyer’s ability to meet the debt service coverage ratio and net worth thresholds. The lender will want the same from any proposed key principals or guarantors joining the loan. Lender will also need current financials, leases, and rent rolls, from the commercial property, certifying the property’s healthy financial performance. The lender will expect all of these items to be provided throughout the life of the loan as well.

During the evaluation process, a buyer should verify there are no overdue lender requirements that the seller has failed to fulfill. Some sellers may be looking to offload a property because of outstanding repairs or poor financial performance, and see a loan assumption as an easier way to escape loan conditions and pricey prepayment penalties. Buyers should request any recent inspections of the property completed by lender, looking for outstanding repairs or other issues noted by the inspector.

Once a buyer is approved for the loan assumption and closes on the property, the buyer will be responsible for all of seller’s loan obligations under the assumed loan, including payments, property maintenance, and averting defaults as they are defined in the loan agreement. However, sellers should note that some loan assumptions keep the seller on the hook, similar to a guaranty, for any buyer defaults following the assumption.  A seller should ensure that they are provided a full release of all loan obligations upon buyer’s assumption of the loan.

A loan assumption is a great way for buyers to finance a purchase at lower than market interest rates with reduced closing costs; and for sellers to steer clear of high prepayment premiums. If you’re looking into or currently undertaking a loan assumption and would  like to discuss your options please feel free to reach out to me at smacpherson@patellegal.com or (972) 435-4339.