A mortgage assumption is an arrangement where the buyer of a home assumes all of the obligations of the seller's original mortgage---mortgage balance, monthly payment schedule, the term of the mortgage, and the interest rate.
Mortgage assumptions become more attractive as rates go higher. If the best rate you can get from a lender is 7%, and you find a home whose seller has a mortgage at 5.5%, a mortgage assumption could save you a lot of money. Assuming, of course, that the seller and the lender will agree to a mortgage assumption.
The best scenario for the buyer would be assuming a mortgage, and having enough cash to pay the seller the difference between the mortgage balance and the selling price. If this isn't the case, the buyer will have to get a second mortgage on the home for the difference, and will have to pay market interest rates.
Because the buyer is getting a great deal from a mortgage assumption, he should recognize that the seller deserves something as well. Usually the seller's benefit will be a higher price for the home.
Lenders are generally not fond of mortgage assumptions, and for good reason: they would make more money if the buyer were paying 7% on the full value of a new mortgage rather than on just a portion of a new mortgage.
Decades ago, mortgage lenders tried to prohibit mortgage assumptions, but the courts ruled against the lenders. To prevent mortgage assumptions, lenders began inserting "due-on-sale" clauses in mortgage contracts, which require the the entire mortgage balance be paid when a home is sold.
Some lenders will allow mortgage assumptions, and will keep the current mortgage on the books, but will raise the interest rate on the mortgage to the prevailing rate (the 7% rate mentioned above, for example). The buyer still benefits from this type of mortgage assumption, though, because on a mortgage that's been in effect for several years, the monthly payment pays down the principle balance much faster than a "new" mortgage would.
The exception to due-on-sale clauses is FHA and VA mortgages. These mortgages allow for assumptions.
Sellers who agree to allow the buyer to assume the existing mortgage should take precautions, and make sure that the seller is not liable for the mortgage if the buyer fails to make payments.
Older FHA and VA loans did not automatically release the seller from liability. If you're a seller with one of these types of loans, you absolutely must get a written release of liability from the lender. Without such a release, not only will the seller face the possibility of being responsible if the buyer defaults on the mortgage, but the lack of such a release will also make it more difficult for the seller to get his own mortgage on another house.
Home owners who took out assumable mortgages from 2000 to 2005 have a very valuable sales tool at their disposal, as mortgage rates hit their bottoms during those years.
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