As a real estate investor, one thing is for certain: there’s a good chance you will need to get creative with your financing options. While private money lenders, hard money lenders, and even traditional mortgages are great options for securing funding, they may not always suffice. Investing in real estate is nothing if not complicated, and may require alternative forms of financing to realize a deal. That said, there’s one more financing method today’s investors should have in their arsenal: the subject to mortgage. A great alternative financing option, a subject to mortgage can tip the scale in buyers’ favor, but only when carried out responsibly and with the proper knowledge of how to proceed.
A subject to mortgage is, as its name suggests, a mortgage that is subject to an existing mortgage. In other words, the seller in a subject to deal isn’t paying off their current mortgage, but rather having the new buyer pay off their existing obligations. Often misunderstood, subject to mortgages are not as complex as many initially assumed. If for nothing else, few people are actually aware of what a subject to mortgage is, but the answer is in the name. In its simplest form, the “subject to” in a subject to mortgage refers to the loan that’s already in place. When you purchase a property subject to, you are essentially buying the home subject to the existing mortgage — that’s really all there is to it. The original underwriting is kept as is, including the name in which the loan was purchased. That means the seller maintains the responsibility of paying off the loan, but the buyer has agreed to make mortgage payments on behalf of the original seller. Over the course of a subject to mortgage, the buyer will make payments to the seller, who will, in turn, pay off the mortgage in return for the deed.
It is important to note that the seller will not be paying off the current loan, but rather using the payments they receive from the impending buyer to do so. That means the homeowner’s current unpaid balance will factor into the purchase price for the new buyer.
The buyers in a subject to “transaction” do not formally assume the loan, but they are given the deed in return for making payments. In other words, they take control of the home without assuming the mortgage. Payments are, therefore, made to the seller, so that they may pay the original loan from the money they receive from the buyer each month. The terms the buyer creates with the seller are unique to each situation, and agreed upon by the two parties before a deal being struck. As a result, subject to financing requires little to no money down and, when used properly, can provide an alternative, viable financing strategy.
Subject to strategies aren’t all that common, but you will find that they can be useful in certain circumstances. Distressed sellers, for example, may be willing to sell subject to if they want to rid themselves of a property immediately. Buyers, on the other hand, will tend to favor subject to when the interest rates on the existing loan are lower than the current market rates.
All things considered, there is a time and a place to execute a subject to mortgage, but the process isn’t without risk. Agreeing with a seller is never risk-free, but I digress. Not unlike every other exit strategy, there are pros and cons. The key is to weigh each pro and con, and determine for yourself if a subject to mortgage is right for you. That said, be sure to consult an attorney well-versed in real estate law before you make any decisions for yourself. Until you do, here’s a list of some of the most common pros and cons you can expect to see.
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More often than not, the primary reason for buying a subject to property is to capitalize on the current owner’s interest rate. Buyers taking on the existing mortgage will, therefore, want to make sure it’s a good time to be doing so. In a low interest rate environment, like today, it may not make a lot of sense to purchase a subject to property. In the event interest rates are lower than the existing rate on the home, buyers may actually lose money. However, it makes perfect sense to buy a subject to property with an interest rate that is lower than the current market rate.
Another reason someone may want to buy a subject to property is because of their financial standing and credit history. You see, someone with poor financial credentials and a low credit score may not qualify for the mortgage they need to buy a home. Fortunately, subject to properties offer these buyers a “workaround.” Buyers who don’t qualify for traditional mortgages may buy a subject to property and assume the existing mortgage, all without having to qualify for a subsequent mortgage themselves.
Last, but certainly not least, subject to mortgages eliminate burdensome expenses. Buying a subject to property can eliminate closing costs, origination fees, broker commissions, and other costly fees associated with buying a home.
While it’s common to suspect a subject to mortgage to involve owner financing, that’s not always the case. In fact, there are a few different types of subject to mortgages, not the least of which have intricacies of their own. More specifically, there are three common forms of subject to mortgages investors should familiarize themselves with:
A straight subject to cash-to-loan: The most common of the three, a straight subject to cash-to-loan is when the buyer elects to pay the difference between the purchase price and the existing loan balance.
A straight subject to with seller carryback: Otherwise known as seller or owner financing, a straight subject to with seller carryback loan can take the form of a second mortgage.
Wrap-around subject to: The third type gives sellers the ability to conduct an override of interest because of the money they expect to make on the existing mortgage balance.
Subject to mortgages are a widely used and viable source of alternative financing. However, it’s important for investors who want to use a subject to mortgage to fully understand what they are getting into. In particular, investors should be able to identify the differences between assumed mortgages and subject to mortgages. Coincidently, the two are not interchangeable and have caused some confusion in the real estate industry.
As you have already learned, a subject to mortgage is a mortgage that is subject to an existing mortgage. The seller in a subject to deal isn’t paying off their current mortgage, but rather having the new buyer pay off existing obligations. Assumed mortgages, on the other hand, delegate liability. In the event a buyer follows through with an acquisition and assumes the mortgage, they are then liable for the debt. Not unlike a traditional loan, buyers will assume the mortgage given to them by the lender. As the name suggests, the seller in an assumed deal is no longer primarily liable. If the mortgage is subject to, however, the seller is not released from their obligations.
Subject to is far from the only financing option made available to today’s investors; it’s merely a complement to every other strategy out there. If for nothing else, the more financial strategies you have at your disposal, the more likely you will be to use one to land your next deal.
Subject to strategies are an alternative to traditional financing; one that could come in handy when the right situation presents itself. That’s an important distinction to make, as subject to financing is a niche strategy — there are a time and a place to use it. Here’s a look at some of the most obvious pros and cons of subject to financing to give you an idea of whether or not it remains an option for your next acquisition:
Cash Flow & Equity: Provided the right steps have been taken, the property can very easily award buyers with cash flow and the chance to build equity. You see, in a subject to, the buyer takes control of the home while the seller “owns” the loan. That means the benefits of real estate fall directly to the buyer once they take control.
Lower Barrier To Entry: Subject to financing strategies allow buyers to acquire properties without committing to the large down payments we have grown accustomed to. The initial payment doesn’t need to be 20 percent, as one could expect if they wanted to acquire a loan without private mortgage insurance.
No Credit Necessary: Sellers are not basing the transaction solely on the buyer’s credit history. That can mean one of several benefits: the buyer can follow through with a purchase without a pristine credit history, or they are free to leverage their credit in an additional purchase. If you so desired, you could still use your credit to acquire a traditional loan while simultaneously carrying out a subject to.
The Deal Is Final: For better or for worse, subject to transactions are final. Provided everything goes well, that’s exactly what you’ll want, but there’s always the chance the market changes. In the event things take a turn, there’s no turning back. Over the course of subject to deals, you now have an ethical responsibility to the seller.
The Loan May Be Called Due: There is a possibility that the lender could call the loan due if they realize the home has been transferred. In that case, they may require the loan to be paid in full within 30 days.
Insurance Requirements: You will need to obtain a new insurance policy naming you or your company as the insured on the policy.
Credit Risk: If you don’t make payments on time, you can hurt the seller’s credit, and risk foreclosure.
Buying subject to carries risks for homebuyers and may expose sellers to liability. Because of these potential risks, it is strongly recommended that you seek legal guidance on the required paperwork and risk adherence.
While already hinted at in the previous “cons” section, the due on sale clause is worth repeating. If for nothing else, the idea that the loan may be called due sooner rather than later is potentially the biggest pitfall of a subject to mortgage. To be clear, however, most loan originations contain a due on sale clause. Due on sale clauses typically state that the loan originator has the right to call the loan due in full in the event the title transfers from the original borrower to another. The idea of a due on sale clause is to protect the lender from their loan transferring to unqualified borrowers. Therefore, if the title changes hands, the lender may ask the new titleholder to pay the loan in full, which can make things extremely difficult for some. That said, these clauses only give lenders the right to make the loan due, it doesn’t mean that they will. Nonetheless, it’s still something investors need to keep in mind.
Not unlike the due on sale clause, the insurance requirements bear worth repeating. As perhaps one of the biggest pitfalls of a subject to mortgage, the parties must decide who will insure the property. Perhaps even more importantly, will a change in the insurance policy trigger the due on sale clause? There’s a lot to think about, and insuring the home is no exception. It has become common practice for the owner of the property to own the insurance policy, but since there are no hard and fast rules there gets to be some confusion.
To find subject to properties, investors first need to understand why some sellers will be motivated to seek a subject to deal. That said, there are two common reasons a homeowner would consider using a subject to mortgage strategy: they either can’t sell at the price they want or they simply need to sell sooner rather than later. The former reason would suggest the homeowner has little to no equity, and need to sell at a certain price—no exceptions. The latter of the two reasons is pretty self-explanatory; they either can’t make payments anymore or they simply need to move as soon as possible.
When all is said and done, buyers simply need to ask sellers if they would like to conduct a subject to sale (if it is even possible). At the very least, you’ll never know until you ask. On the other hand, it may pay to take a trip to the local courthouse and identify distressed homeowners. Homeowners behind on payments are public knowledge and are made available to those who inquire. Therefore, buyers looking to exercise a subject to strategy should first identify distressed homeowners, and then proceed to formulate a market strategy founded on the principles of a subject to mortgage.
Most investors will rarely use a subject to mortgage strategy, but I digress. A subject to mortgage contract isn’t meant to be your only means of financing a deal, but rather a compliment to the strategies you already have in place. Simply knowing how to utilize the correct subject to mortgage clause is a great tool to have at your disposal, should the right situation present itself. If for nothing else, the more financing strategies you know, the more deals you’ll likely be able to close. Therefore, if you want to give yourself the best odds of landing more deals, you need to know how to close more deals, and a subject to mortgage agreement is a great place to start.