Assumable Mortgage
Your house has a mortgage on it. You paid $200,000, borrowed $600,000, and are now selling the house for a cool million bucks. The $600,000 mortgage you have on your home was raised in an era with extremely low interest rates. In your case, just 4.5%. The buyer coming along, paying a million bucks for your house, in most states, has the legal right to assume your mortgage.
That is, as long as they agree to live by the same terms that you lived by, they can take over your mortgage and adopt it as one of their own. In the case where the buyer has $400,000 lying around, they can literally be done with the purchase after assuming your loan because their $400,000 will comprise the down payment.
Why would anyone want to assume a mortgage? Because the current mortgage environment has a cost structure much higher than the mortgage they want to assume. For example, the new environment might be charging 7% for a similar loan, and in the buyer's ability to assume the mortgage at 4.5%, they're saving 2.5% per year in rent costs on that $600,000, or something near $15,000 per year in interest cost savings, albeit pre-tax.
Related or Semi-related Video
Finance: What is Collateralized Mortgage...65 Views
Finance a la shmoop what is a collateralized mortgage obligation or
CMO all right people well this is a GMO and this is a CMO yeah it's a bunch of
mortgages in one investment vehicle pot like mortgage Stone Soup not nearly as [Mortgage stones in a bowl of soup]
exciting is that that man-eating plant over there
so yeah just a bunch of mortgages that are packaged together when banks and
investors package mortgages together well they can treat them like they're a
big fat indexed bond fund because these groups of mortgages while they pay
interest ie the interest comes from the people who are actually paying off their
mortgages so why would you collateralize a mortgage obligation anyway answer risk
by packaging lots and lots of mortgages together the theory was that well as a [CMO boxes on a conveyor belt]
whole they would create a much less volatile environment than the former
alternative of having tens of thousands of individual mortgages many of which at
any given time were you know in do rest as people were dead beating and not [Man playing video games]
paying what they promised to pay back right well collateralizing this group
meant simply placing all of them into one investment vehicle that could be
bought and sold as if it were in ETF or individual closed end fund but Wall
Street being Wall Street where greed is good until it's not abused the notion of [Boxing gloves punch collateralized]
collateralized mortgages and actually applied the notion of collateral against
them pledging as collateral the equity in these mortgages or packages of
mortgages and then borrowing against them so it's like leverage on leverage,
highly volatile and this is sort of like the brilliant idea of the fraternity [Man walking along]
social chairman sending the pledges to get graham crackers marshmallows and
chocolate when he sees his you know couch is on fire yeah like why wouldn't [People carrying snacks and a couch on fire appears]
he just put it out like what was he imbibing there all right well in fact
this is more or less what happened in the mortgage meltdown of 2008 and 9 and
it was helium inside of the couch that exploded in the form of many of these [Helium explodes on a couch]
mortgages becoming insolvent and as one mortgage went bad
well it caused a chain reaction of panic up and down the economic food chain
which resulted in the near bankruptcy of the United States financial system
basically the people who pulled together these CMOS forgot what the O stands for [Man walking along the street and plant eats him]
oh dear, oh my
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