Just because we don't have any histories from the 7th century BC doesn't mean every text written in the 7th century was history. History as a genre wasn't really invented until Herodotus, in the 420s BC: prior to that there were genres that had some points in common with history - genealogical records, lists of kings and of athletic victors, and the like, and apparently even some ethnographies - but no attempts to put in writing a synthesis of research and reasoning about causes. The exact compositional processes that went into the making of the Iliad are debated, but they certainly did include creative processes, and they certainly did not include research.

Obviously, myths and legends would have been told on the assumption that they were true.

This is a misconception. At the time when history as a genre started up, folks did acknowledge mythical sources as a possible source of information about the past, and selectively reported elements from them as quasi-historical. So we get Herodotus talking about when he thinks Dionysus was born, when he thinks Heracles lived, and when he thinks the Trojan War happened.

But two things: (a) they were also pretty sceptical about them: these bits of Herodotus are not blindly reporting myths as fact, they represent an attempt to rationalize myth and distill historical elements out of myth. Thucydides is more sceptical still: he bluntly rejects the historicity of Homer, while accepting that in broad outline the myth represented a historical event. (He still wasn't up to modern standards, of course: nowadays we would not presume any historical content in myths without independent corroboration.)

And (b) in general we cannot assign to any mythical texts a motivation of trying to record the past. Mythical texts are texts that were designed for contemporary concerns and for contemporary political and social concerns. The class structure in the Iliad is aristocratic 7th century society, not the Mycenaean palace culture. The same goes for religious customs, marriage customs, military equipment, the geopolitical layout of Greece, and so on: all 8th-7th century. The aspects of the Iliad that actively try to capture the past are relatively limited in scope: the poem imagined a past based on what the present looked like, and that meant isolating elements of 7th century society that were believed to be recent developments, and quietly pretending that they didn't exist - things like assemblies, iron, colonization, and trade; or projecting mythical traditions back into the past: e.g. tradition had it that humans got weaker and smaller as time went on, so the heroes in the Iliad are bigger and stronger than real humans. Strewn in among that are a few genuine echoes of the past: place names that no longer existed, a Bronze Age helmet. But these are isolated snippets. When people made a concerted effort to record the past, the end product was Olympic victor lists. That's clearly not what the Iliad is trying to do.

If "history" as a genre didn't exist, there's no particular reason to imagine that "fiction" as a genre existed. The modern novel wasn't invented until the modern era. But it's easy to see some aspects of the the creative motivations that go into the modern novel in ancient texts, just like it's easy to see historical motivations going into things like Olympic victor lists.