Understanding Loan Assumption
What Is Loan Assumption?
Much like in residential mortgage finance, some loans in commercial real estate have an assumability clause. An assumability clause allows the buyer of a commercial asset to take over the initial financing for the property from the seller, rather than having to obtain new financing. Even so, in most cases when a loan is assumable, the buyer must still meet strict borrower requirements in order to be eligible for the loan assumption — after all, lenders must ensure the new borrower has the financial means to continue repaying the loan and that they aren't a financial risk.
In many cases where loan assumption is allowed, like with HUD multifamily loans, a buyer must pay a fee — typically between 0.05% and 1% of the original loan amount to assume the loan. CMBS financing sometimes allows loan assumption as a means of avoiding strict prepayment penalties associated with conduit loans, generally along with a standard 1% assumption fee as well.
How Loan Assumption Works
First and foremost, in order to assume a commercial mortgage, the original loan documentation must include an assumption clause. Understandably, the majority of commercial mortgage loan products available are not, in fact, assumable. In general, lenders are typically opposed to loan assumption because they originate mortgages with terms based on the creditworthiness of the original borrower.
There are also challenges involved in determining whether or not a new borrower can safely assume the original debt, and many lending institutions are simply unwilling to take on the risk. Additionally, a key factor behind lenders’ hesitance to allow loan assumption is that, even if a new borrower meets creditworthiness requirements and can assume the loan with little to no risk, the lender would still miss out on some of the more common fees that are usually tied to a new mortgage loan.
Loan Assumption as a New Borrower
Loan assumption can be quite an attractive option for investors if current market rates are higher than the rate on the seller’s mortgage. In addition, the buyer may also be able to avoid having to pay many of the typical closing costs like the title search, document stamps, taxes, and so forth. Even so, they are generally faced with an assumption fee, depending on the exact stipulations of the assumption clause.
When an investor decides to assume a mortgage, the lender must first qualify them as a new borrower. In most cases, qualification requires standard borrower financial profiling. Investors may be required to provide two to three years of tax returns and a personal financial statement of assets and liabilities, and they often must meet strict debt service coverage ratio requirements.
Assuming a commercial mortgage is a different experience than obtaining a conventional commercial loan — with added responsibilities. Assumed commercial mortgages are often tied to reporting requirements and covenants. Many lenders require that the borrower of an assumable loan provides updated tax returns and financial statements on an annual basis. For assumable loans that use an apartment or multifamily property as collateral, leases and rent rolls are often required submissions as well.
Related Questions
What is loan assumption in commercial real estate?
Loan assumption in commercial real estate is a process where the buyer of a commercial asset takes over the initial financing for the property from the seller, rather than having to obtain new financing. In most cases, the buyer must still meet strict borrower requirements in order to be eligible for the loan assumption. In many cases, a buyer must pay a fee — typically between 0.05% and 1% of the original loan amount to assume the loan.
When an investor decides to assume a mortgage, the lender must first qualify them as a new borrower. In most cases, qualification requires standard borrower financial profiling. Investors may be required to provide two to three years of tax returns and a personal financial statement of assets and liabilities, and they often must meet strict debt service coverage ratio requirements.
Assuming a commercial mortgage is a different experience than obtaining a conventional commercial loan — with added responsibilities. Assumed commercial mortgages are often tied to reporting requirements and covenants. Many lenders require that the borrower of an assumable loan provides updated tax returns and financial statements on an annual basis. For assumable loans that use an apartment or multifamily property as collateral, leases and rent rolls are often required submissions as well.
What are the benefits of loan assumption for commercial real estate?
The benefits of loan assumption for commercial real estate include avoiding the need to obtain new financing, potentially avoiding closing costs, and having the option to take advantage of lower interest rates than the seller's mortgage. Additionally, loan assumption can provide more exit flexibility for borrowers and less prepayment risk for bondholders.
When assuming a loan, the buyer must still meet strict borrower requirements in order to be eligible for the loan assumption. This includes providing two to three years of tax returns and a personal financial statement of assets and liabilities, and meeting strict debt service coverage ratio requirements.
In many cases, a buyer must pay a fee — typically between 0.05% and 1% of the original loan amount to assume the loan. Additionally, assumed commercial mortgages are often tied to reporting requirements and covenants. Many lenders require that the borrower of an assumable loan provides updated tax returns and financial statements on an annual basis. For assumable loans that use an apartment or multifamily property as collateral, leases and rent rolls are often required submissions as well.
What are the risks associated with loan assumption in commercial real estate?
The risks associated with loan assumption in commercial real estate include the lender needing to ensure the new borrower has the financial means to repay the loan and that they aren't a financial risk. Additionally, for some kinds of loans, such as HUD multifamily loans, having a new buyer assume a loan requires a small fee of between 0.05% and 1% of the original loan amount. In many situations, CMBS loans are also assumable for a small fee.
What are the requirements for loan assumption in commercial real estate?
When an investor decides to assume a mortgage, the lender must first qualify them as a new borrower. In most cases, qualification requires standard borrower financial profiling. Investors may be required to provide two to three years of tax returns and a personal financial statement of assets and liabilities, and they often must meet strict debt service coverage ratio requirements.
Assuming a commercial mortgage is a different experience than obtaining a conventional commercial loan — with added responsibilities. Assumed commercial mortgages are often tied to reporting requirements and covenants. Many lenders require that the borrower of an assumable loan provides updated tax returns and financial statements on an annual basis. For assumable loans that use an apartment or multifamily property as collateral, leases and rent rolls are often required submissions as well.
In many cases where loan assumption is allowed, like with HUD multifamily loans, a buyer must pay a fee — typically between 0.05% and 1% of the original loan amount to assume the loan. CMBS financing sometimes allows loan assumption as a means of avoiding strict prepayment penalties associated with conduit loans, generally along with a standard 1% assumption fee as well.
What are the steps involved in loan assumption for commercial real estate?
In order to assume a commercial mortgage, the original loan documentation must include an assumption clause. The new borrower must also be approved by the lender, who needs to ensure the borrower has the financial means to repay the loan, and that they aren't going to be a serious financial risk. For some kinds of loans, such as HUD multifamily loans, having a new buyer assume a loan requires a small fee of between 0.05% and 1% of the original loan amount. In many situations, CMBS loans are also assumable for a small fee.
The steps involved in loan assumption for commercial real estate are:
- The original loan documentation must include an assumption clause.
- The new borrower must be approved by the lender.
- The lender needs to ensure the borrower has the financial means to repay the loan, and that they aren't going to be a serious financial risk.
- For some kinds of loans, such as HUD multifamily loans, having a new buyer assume a loan requires a small fee of between 0.05% and 1% of the original loan amount.
- In many situations, CMBS loans are also assumable for a small fee.