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Novation comes from the Latin word "nova," meaning "new." A novation is a process of substituting a new debtor, or in general terms, a new loan agreement, for an old one.
The bank or other lender must approve the novation and can set the terms of the transfer, including the repayment schedule; any fees that may be charged for the procedure, such as document fees; the pulling of a credit report on the new debtor; and taxes.
A novation is sometimes used when a debtor is having difficulties repaying a secured loan and the lender chooses not to foreclose and seize the property. A novation most commonly takes place when a borrower transfers the entire debt to a cosigner on the original loan and is then released from any responsibility for repayment. Most lenders, however, demand that any new borrower qualify for and refinance the loan at current interest rates,
rather than simply taking over payments on the old terms. The bank enforces lending guidelines and generates fees through the loan qualification process.
Assumption and Novation
Novation is distinct from assumption, in which a second party takes over payments but the original borrower remains responsible for repayment in case of default. Some forms of assumption also expect the original borrower to make up any shortfall if the property is sold on foreclosure for less than the outstanding loan amount.
Novation can also refer to the substituting of a new loan agreement for an old one that has become unworkable for the borrower. The repayment schedule may be extended, or a grace period may be allowed in which interest-only payments are made and the principal balance remains constant. Lenders don't normally offer novation unless a borrower specifically requests it. The terms of a novation may include any assumption charges that were part of the original loan agreement.