The Hidden Challenges of Assuming a VA Loan

With interest rates higher than they’ve been in years, many homebuyers are searching for ways to lower their mortgage costs. One increasingly popular strategy is assuming a VA loan — taking over a seller’s existing mortgage, often with a much lower interest rate. On the surface, it sounds like a win-win: the buyer gets a low-rate loan, and the seller gets to close a deal faster.

But while assuming a VA loan can be a great opportunity, it’s not without complications. Beneath the attractive benefits are some serious potential downsides that both buyers and sellers need to understand.

The VA Entitlement Issue

To hold a VA loan, a VA Entitlement is required.  Veterans receive VA Entitlements as a benefit and can use that VA Entitlement to assume an existing VA loan on a property they purchase. They can also use it to initiate a new VA loan.  There’s no issue.

But, if the purchaser is not a veteran and doesn’t receive VA benefits, the situation gets more complicated.  In this case, if the non-veteran assumes the loan, the seller’s VA Entitlement remains tied to that loan until it is paid off.  That means that the seller cannot use their VA loan benefit to purchase another home during that period.  And if the purchaser doesn’t prepay or refinance the loan during their time of ownership, that time period could extend for decades.  For this reason, we’ve found that most (but not all) sellers are unwilling to give up their VA Entitlement to a non-veteran purchaser.

The Down Payment Issue

VA loans enable veterans to purchase homes with little or no down payment.  But during the time period that a veteran owns a home with a VA loan, it’s likely that the value of the home will increase while principal is simultaneously paid down.  When that veteran turns to sell the home, that home may be valued far higher than the loan balance. When purchasers assume a VA loan, they do so at the loan’s current balance and must make up the difference between that balance and the purchase price with down payment cash.

For example, a homoe may be valued at $600,000 while the VA loan balance may only be $300,000. In this case, the purchaser would need to produce $300,000 in cash plus closing costs to complete the transaction.  For most buyers, that’s a lot.

It may be possible to add a “piggyback loan” to help bridge the down payment gap.  These are typically issued as conventional second mortgages.  They can be difficult to find, as most lenders don’t issue them.  If purchasers can find them, they typically carry high interest rates — usually far higher than the prevailing conventional mortgage rates.  Many purchasers find that when the low-rate on the VA assumption is combined with the high-rate piggyback loan, the blended rate exceeds the cost of obtaining a new conventional loan.  In other words, the low-rate benefit of assuming a VA loan is entirely negated.

The Approval Process Issue

Most VA loan assumptions are not quick transactions.  Even in cases where the purchaser has their paperwork in order, it can take one to two months for the lender and the VA to review, approve, and finalize the assumption.  Some lenders may drag their feet or lack the experience to process assumptions efficiently, leading to unnecessary delays and potential fallout if the buyer or seller gets impatient.  And just as in obtaining a new loan, the purchaser assuming the VA loan must meet stringent lender criteria, including creditworthiness and debt-to-income ratios.

What about FHA Assumptions?

Like VA loans, FHA loans are assumable, enabling purchasers to take advantage of sellers’ low mortgage rates on their existing loan.  And with an FHA loan, the VA Entitlement is not an issue.  However, the down payment issue remains.  Purchasers can only assume the existing balance of the FHA loan and must make up the difference in loan balance vs. purchase price using cash or an expensive piggyback loan.

Final Thoughts

Assumption of a VA loan can be an excellent opportunity for the right buyer in the right situation.  However, buyers should be aware of the issues around VA loan assumption.  Working with a real estate broker who has experience with loan assumptions can be helpful.