What is an Assumable Loan in Commercial Real Estate?

Assumable Loans in Commercial and Multifamily Real Estate 

An assumable loan is a loan that can be assumed, or taken on, by a new borrower before the end of the loan’s term. Many types of loans are assumable, including most Fannie Mae, Freddie Mac, HUD multifamily, and CMBS loans. Some bank and life company loans may also be assumable, depending on the individual lender. 

What are the Benefits of Assumable Loans? 

If a property has an assumable loan, it may be easier to sell, because it is far easier for a new borrower to assume a current loan rather than to take out new financing altogether.  This makes assumable loans a benefit for both the seller and the potential buyer of the commercial property. Assumable loans are particularly ideal when: 

  • There is still a long term (and high leverage) left on the loan 

  • The loan is at an equal or lower fixed-interest rate than the current market interest rates

  • The loan allows supplemental financing to increase leverage for the new borrower 

In an environment of high (or rising) interest rates, a fixed-rate loan set at a lower interest rate will allow a borrower to get lower-rate financing than they could anywhere else. Most lenders set loan assumption fees at around 1%, which is relatively affordable. 

In general, loan assumption is cheaper for the new borrower because they will not need to pay high lender fees and acquire third-party reports such as an environmental assessment, engineering report, zoning report. In most cases, only an appraisal and a physical needs assessment (PNA) will be required. Because of this, deals involving assumable loans can often close much more quickly than those in which a buyer needs to get original financing from a lender. 

The major limiting factor in the loan assumption process is the qualifications of new borrowers. Borrowers will still need to match the borrower qualifications for that lender and loan type, which generally include: 

  • Credit score check

  • Background check

  • Borrower bio/commercial real estate experience (for some loans)

  • Borrower/sponsor net worth and liquidity requirements 

Assumable Loans Can Help Sellers Avoid Prepayment Penalties

If a borrower wants to sell a property prior to loan maturity, they will generally have to incur a prepayment penalty. This can be a serious expense for an investor. Prepayment penalties are typically higher the sooner a borrower wishes to repay the loan, and many loans have a 1-2 year lockout period in which they are fully prohibited from prepaying the loan. 

Prepayment penalties generally come in one of three forms; a percentage based step-down, which could be, for example, 5% of the remaining loan amount in the second year, 4% in the third year, 3% in the second year, and 2% for the remaining life of the loan. Prepayment penalties are generally waived in the last 90 days of the life of the loan. 

Other forms of prepayment include defeasance, which involves replacing the collateral of the loan with equivalent income-producing securities, typically Treasury or other government-backed bonds. This usually requires the assistance of an outside consultant and can be quite expensive. 

The other common type of prepayment penalty is yield maintenance, which can either be set as a particular percentage based-fee or is calculated based on the difference between the current market interest rate and the rate of the loan. If current market interest rates are higher than the loan interest rate, yield maintenance and defeasance will be less expensive, as the lender is losing out on less potential income from the loan. 

Having another borrower assume the loan can allow the current owner to avoid all these fees, allowing them to save significant money in the disposition process. 

Loan Assumption is Ideal for Long-Term Fannie, Freddie, and HUD Loans 

As a final note, properties with long-term loans from HUD multifamily, which can reach up to 40-years for new construction/substantial rehabilitation, and up to 35-years for purchases and refinances, can be particularly attractive for buyers looking to assume a loan. In the case of HUD apartment loans, a borrower can take out a HUD 223(a)(7) refinance to increase their leverage just a few years after taking out their original loan. 

The same can be said for Freddie Mac and Fannie Mae multifamily loans, which can extend up to 20 and 30 years, respectively. These loans also have supplemental financing options.