Loan Assumption

Definition of Loan Assumption

A loan assumption is a legal transaction in which a buyer of a commercial property takes over the existing mortgage and its specific terms from the seller. Instead of the buyer obtaining a new loan to finance the acquisition, the buyer steps into the shoes of the original borrower, inheriting the remaining balance, the interest rate, the repayment schedule, and all other conditions stipulated in the original promissory note.

Detailed Description of the Commercial Loan Assumption Process

In the context of commercial real estate finance, a loan assumption is not an automatic right. Most commercial mortgages contain a "due-on-sale" clause, which prevents the transfer of the property without the lender's express written consent. Therefore, a commercial loan assumption is a rigorous process involving the lender, the seller (assignor), and the buyer (assignee).

The primary components of a commercial loan assumption include:

• Lender Approval: The lender must conduct a full underwriting of the buyer. This includes reviewing the buyer's financial statements, credit history, and experience in managing similar commercial assets. The lender must be satisfied that the new owner is as creditworthy as, or more than, the original borrower.
• Assumption Fees: Lenders typically charge an assumption fee for processing the request. This fee usually ranges from 0.5% to 1.0% of the outstanding loan balance, though it can vary based on the complexity of the deal.
• Release of Liability: A critical step for the seller is obtaining a formal release of liability. Without this, the seller may remain secondary liable for the debt if the buyer defaults in the future.
• Documentation: The process requires a "Loan Assumption and Release Agreement," which legally transfers the obligations and modifies the original loan documents to reflect the new ownership structure.

Strategic Advantages and Considerations

Loan assumptions are particularly popular in high-interest-rate environments. If a property was financed several years ago at a significantly lower interest rate than what is currently available on the market, the ability to assume that low-rate debt makes the property much more attractive to potential buyers.

Benefits for the Buyer:

• Access to below-market interest rates.
• Potentially lower closing costs compared to originating a brand-new commercial loan.
• Avoidance of certain loan origination fees and extensive appraisal wait times.

Benefits for the Seller:

• Avoidance of prepayment penalties, such as yield maintenance or defeasance, which can be prohibitively expensive in commercial contracts.
• Increased marketability of the asset by offering "favorable financing" to prospective purchasers.

Potential Challenges:

• The buyer may need to provide a significant amount of equity if the loan-to-value (LTV) ratio has decreased since the loan was first originated.
• The process can be time-consuming, sometimes taking 60 to 120 days for lender approval.
• The lender may require an Assumption Carve-out, requiring new "bad boy" guarantees from the buyer's principals.

In summary, a commercial loan assumption is a sophisticated financial tool that requires careful coordination between the buyer, seller, and lender to ensure that the debt transition is seamless and legally binding.