While traditional approaches to real estate investment, such as financing a property through conventional mortgages or private money lenders do work, sometimes they may not be sufficient for your situation.
If you are a real estate investor, a new buyer, or a seller, it’s always a good idea to keep your options open.
A more creative financing option, such as a subject-to real estate deal, could be a good alternative for you.
What Is Subject-To Real Estate?
Entering into property subject-to deal means buying a home subject to the seller’s existing mortgage already in place, without a lender.
A subject-to-sale agreement means the seller will not be paying the rest of the mortgage.
In this case, the buyer will be taking over the remaining mortgage payments as the property is subject to the existing loans.
However, that does not mean that the loan is transferred to the name of the buyer.
The mortgage loan stays under the name of the seller while the buyer takes the title of the property and is responsible for existing payments.
The outstanding balance of the existing mortgage is considered part of the purchase price.
Although it’s agreed upon that the buyer will handle the remaining mortgage payment in a subject-to situation, they are not legally obligated to fulfill them.
Since there is no official agreement made with the lender, the home will be lost to a foreclosure if the buyer fails to make the payments.
Three Types of Subject-To Real Estate Deals
There are a few options of subject-to agreements to choose from. Figuring out which best works for your financing options will allow you to take advantage of each opportunity.
A Straight Subject-To Cash -To-Loan
This type of subject-to sale is the simplest and most commonly used type of subject-to property deal. This is when a buyer pays the difference between the purchase price and the seller’s existing mortgage balance.
For example, if the existing loan balance is $100,000 and the purchase price is $150,000, the buyer will have to pay $50,000 in cash to the seller.
A Straight Subject-To with Seller Carryback
A subject-to with seller carryback is also known as owner financing, which is most often found in the form of a second mortgage.
Owner financing means the seller will be carrying any remaining balance after the buyer makes a down payment.
A seller carryback might also be a land contract or a lease option sale instrument.
For example, in this type of real estate deal, if the property sales price is $150,000 while the loan balance is $100,000, the buyer will make a down payment of $30,000.
This leaves the seller to carry the remaining balance of $20,000 at different interest rates negotiated between them.
The buyer would then agree to make a payment to the lender while making another payment at a separate interest rate to the seller.
A Wrap-Around Subject-To
In a wrap-around subject-to, the seller charges money on the existing mortgage balance.
For example, an existing loan balance carries a 5% interest rate. If the sales price is $200,000 and the buyer makes a down payment of $20,000, then the seller carryback will be $180,000.
Now, the seller can carryback a mortgage rate of 6% and wrap it around the existing mortgage. The buyer would then pay 6% on the $180,000 to the seller.
This way, the seller can make payments on the existing mortgage balance while keeping the 1% difference.
Reasons for Buying a Home Subject-To Real Estate
A subject-to real estate deal may be a win-win situation for sellers and buyers alike.
For a Seller
A subject-to-deal is a creative financing option that is often best suited for a homeowner who has been behind on payments.
For motivated sellers, someone showing interest in purchasing their home subject-to means that there is a way to keep the property from foreclosure.
It is also a good strategy to keep the seller’s credit score suffering from late payments.
For a Real Estate Investor
As an investor, there are sundry reasons to buy an investment property subject-to. It could be an investing strategy, opening new investors up to different options of real estate investing.
The most significant benefit of buying subject-to real estate is there are far fewer costs when purchasing the property.
There are no closing costs, origination fees, or broker’s commission. For investors, no closing costs or fees mean a higher profit margin for selling in the future.
Obtaining a property subject-to also means they can take advantage of the seller’s existing interest rate on the house.
The seller’s existing interest rate may be far lower than the present interest rates, and that could make a massive difference in terms of money saved in the future for the buyer.
Another motivation to buy is if the investor does not have sufficient credit to qualify for a loan on their own or if they do not have enough cash.
Risks of Subject-To Real Estate Investing
Yes, subject-to real estate investing is one of the easiest and most straightforward ways to acquire a property. It has several positives, but keep in mind that you should still be cautious as a buyer.
One of the more significant risks for real estate investors is that, although the investor owns the house and the equity in the property, the seller still legally holds the financing commitments of the existing loan taken subject-to.
Although it is a plus that the loan is not under the name of the buyer, this means that at any point in time, the buyer can be affected by the finances of the seller.
This means that if the seller files for bankruptcy, the property may be included and foreclosed.
Responsibility of the Investor
Another risk of subject-to deals is that agreeing to pay someone else’s mortgage is a huge responsibility.
If the investors fail on making payments on time, that reflects poorly on the seller’s credit score.
Although personally, the investors take no hit to their credit because they used subject-to real estate investing, they should still act responsibly and as if they have signed off on the mortgage themselves.
Due on Sale Clause
As real estate investors, it is also vital that you understand how the due on sale clause works in the instance of a subject-to agreement.
A mortgage lender will usually include a due on sale clause in a loan agreement. It prevents someone else from taking over the mortgage and allows the lender to call the loan due if the title is transferred to someone else.
In that case, immediate payment on the mortgage is required.
The due on sale clause essentially protects the lender or the mortgage holder.
However, an investor can bypass this clause by entering into a contract with the seller, granting the buyer the deed but not the mortgage liability, which will be discussed further.
Subject-To vs. Loan Assumption
The main characteristic of the subject-to sale is that neither the buyer nor the seller tells the existing lender that the seller has sold the property.
In this case, the buyer is now the one making the payments without the bank’s official permission to take over the loan.
Sometimes, a lender will put a “due-on” clause in an agreement on the transfer of a property, which is a strategy that requires that the loan be paid in full.
Banks will sometimes call a loan due and payable in full but not always.
Some banks may not require that this clause be included in the contract. Usually, all that matters is that payments on the loan are being made on time, regardless of who is paying.
However, if the buyer makes a loan assumption, they then assume the loan with the bank’s permission.
The loan is no longer under the seller’s name; instead, it is under the name of the new buyer. In this instance, the buyer qualifies for the loan.
A bank will usually charge an assumption fee to process a loan assumption.
Although the fee is far less than that of a conventional loan, compared to a subject-to deal, which has no assumption fee, this difference in the prices could be something to consider.
How to Enter a Subject-To Financing Agreement?
Do Your Due Diligence
As an investor, you have the responsibility to fully understand the loan terms and agreements before entering into a subject-to property agreement.
Doing your due diligence and researching the best options that work for you will ensure you know what kind of agreements you might encounter.
The best way to ensure your safety and security when entering into any type of loan or legal contract is to hire a trusted real estate attorney.
That said, if you were wondering whether or not subject-to sale contracts are legal, yes, they are.
However, laws regarding a subject-to deal differ per state, which is why it is important to have a real estate attorney that you trust to better help you throughout the entire process.
Analyze the Investment Property
Running an investment property analysis is part and parcel when investing in a new property. You have to make sure you are fully aware of the valuation of the property for its future use.
For example, if you plan to rent out the property, doing a property analysis will allow you to estimate the potential rental income and expenses to see if or how it can provide you with a steady cash flow.
You may also want to renovate and sell the house in the future. A property analysis will give you an estimated total cash investment and after repair value, predicting if it is worth investing in the property.
The Bottom Line
Although subject-to real estate agreements may seem like something of a daunting responsibility, it might actually be worth your time to further look into it.
Whether you are an investor, a buyer, or a seller, there are several positives to buying subject-to real estate.
If mortgages are up or investment rates are too high, or your credit just does not cut it, exploring the options that subject-to agreements provide can help you find the best deal for a property sale or investment.
A subject-to real estate is a creative method that an investor should be aware of. It is neither unethical nor illegal and is a legitimate way to start a real estate business with little money.
It is a great way to build up one’s portfolio of properties that produce income for both an experienced investor and someone just entering the business.