Normally, an individual who wants to buy a house will go to a bank and take out a mortgage in order to finance the home purchase. However, an alternative to this process is the assumable mortgage. With an assumable mortgage, the buyer takes over the seller's existing mortgage, and the bank approves this transaction and agrees that the buyer will make the mortgage payments instead of the seller.
Advantages of an Assumable Mortgage
If interest rates have risen since the seller originally took out the mortgage, the buyer is at a distinct advantage. Instead of paying interest at the higher rate, the buyer can continue to pay the interest at the seller's lower, original rate. This advantage helps to sweeten the deal for the buyer, which is why a seller might offer an assumable mortgage.
Risks of the Buyer of an Assumable Mortgage
The assumable mortgage may not cover the full, current cost of the home. Therefore, the buyer may have to pay the difference in a large down payment. Alternatively, the buyer may find an additional method of financing to pay the difference between the assumable mortgage and the price of the house.
In addition, although the mortgage has been assumed from the seller, the bank may make some changes to the original terms of the loan. For example, if the buyer has a higher credit risk than the seller, the terms of the loan must be adjusted appropriately.
Risks of the Seller of an Assumable Mortgage
Even after the assumption has taken place, the seller may still be, to some degree, responsible for the loan repayment. If the buyer defaults on the loan, the bank may be able to hold the seller liable for any parts of the loan that it cannot recover from the buyer. To avoid this risk, a seller can explicitly release themselves from loan liability in writing at the time of the assumption of the mortgage.