The purchase of a home is a very expensive undertaking and usually requires some form of financing to make the purchase possible. In most cases, the potential buyer goes to the bank and takes out a mortgage for the acquisition. The assumable mortgage is an alternative to this traditional technique. With an assumable mortgage, the home buyer can take over the existing mortgage of the seller as long as the lender of that mortgage approves.
If interest rates have risen since the original mortgage was taken out by the seller, the buyer is the party that benefits the most from an assumable mortgage. The reason for this is that if interest rates rise, the cost of borrowing increases. Therefore, if the buyer can take over the seller's relatively lower-rate mortgage, the buyer will save having to pay the higher current interest rate. However, the full cost of the home may not be covered by the assumable mortgage and may require either a down payment on the rest or additional financing.
For example, if the seller only has an assumable mortgage amount of $100,000 but is selling the home for $150,000, the buyer will have to come up with the additional $50,000. In other words, the buyer can only assume $100,000 worth of the cost of the house, meaning the rest of the cost of the house may have to be borrowed at the higher current interest rate. And although the mortgage is assumed from the seller, the lender can change the terms of the loan for the buyer depending on several factors including the buyer's credit risk and current market conditions.
One unique risk for this type of mortgage can exist for the seller of the home. An assumable mortgage can hold the seller liable for the loan itself even after the assumption takes place. As such, if the buyer were to default on the loan, this could leave the seller responsible for whatever the lender is unable to recover. To avoid this risk, sellers can release their liability in writing at the time of the assumption.
For more on the unique characteristics of residential mortgages, check out Understanding The Mortgage Payment Structure, 5 Things You Need to Be Pre-approved for a Mortgage and Mortgages: How Much Can You Afford?.