The Secret Art of Buying Property "Subject To"
Years ago, one of the challenges facing new real estate investors was the lack of information detailing various techniques that could be used to buy properties in creative ways. In today’s real estate world, a real estate investor has access to almost unlimited information; however, this information may be inaccurate or incomplete. Misinformation can block what would otherwise be a great deal or could make a bad deal look good.
One creative method by which real estate may be purchased is called “subject-to” financing. Many people would like to know whether one can really buy a property subject-to the existing mortgage or if it is illegal to do so? If you were to ask 10 different investors or real estate agents this question, you would probably get 10 different answers. Let’s investigate some of the details of subject-to financing so you can decide if this financing technique can be used in your real estate investing business.
What is subject-to financing?
Simply put, buying a property subject-to the existing mortgage means that the title to the property is transferred to the new buyer, but the loan remains in the original borrower’s name. The buyer takes over making the payments on the loan, but does not formally assume the loan. In order to discover the truth about this method of financing, it is necessary to expose and explore the numerous misconceptions surrounding it.
Misconception #1 – Buying a property subject-to the existing mortgage is illegal.
It is not illegal, but you should check with the laws in your state. There are states that have discussed passing legislation to regulate subject-to purchases because of unscrupulous buyers. For this reason, you should consult your attorney to determine your state’s status.
The reason there has been some question as to the legality of buying a property subject-to stems from the fact that most bank mortgages have what is known as a due-on-sale clause. This clause basically says that a lender has the right to call the entire loan due if the property is sold without the loan being paid off in full. The key to understanding the due-on-sale clause is the term “has the right” to call the loan due. The lender has a choice, not an obligation. There is no due-on-sale jail.
The practicality of the matter is as follows: why would a lender disturb a performing loan and chance turning it into a non-performing loan? As long as the payments are being made, the lender is unlikely to call the loan due. Why would the lender want to do so? Banks are in the money business, not the real estate business, and in today’s market, banks already have more foreclosures than they can handle. You can also do a little research on your own. Ask local lenders if they have ever enforced a due-on-sale clause on a performing loan.
Misconception #2 – No rational person would ever sell their home subject-to.
Who are we dealing with in our transactions? Motivated sellers! Motivated sellers have problems − financial problems, personal problems, house problems. They need a way out. If we can provide a solution to their situation, buying the property subject-to will not be a problem. In fact, if the seller is behind on payments and the investor brings the loan current and makes timely payments, the original borrower’s credit will improve. Remember, the loan is in the original borrower’s name and they get the credit for on-time mortgage payments! Use this fact as an added bonus for the seller when discussing the subject-to option.
Misconception #3 – Buying subject-to requires a lot of paperwork and is complicated.
Not so. It is really simple. In fact, a lot of real estate purchase contracts have subject-to as one of the financing options, right along with new financing, seller provided financing, cash, and loan assumptions. If the purchase contract you are using doesn’t have that option, you can write it in the “other” section. For example, you could write:
Total purchase price to be $180,000, payable as follows: subject-to existing mortgage with Brownsville Bank with a balance of $160,000, and monthly PITI payments of $1,024.67; remainder of seller’s equity to be paid in cash at closing.
It’s wise to have the seller sign a disclosure statement indicating they realize that there is a due-on-sale clause that could be enforced by the bank. Consult your attorney to prepare this disclosure. Full disclosure to all parties is essential. Also have the seller prepare a letter to the bank telling them that all future correspondence should be sent to the new buyer. The letter states that payments will now be coming from XYZ Company. This is not uncommon, as many homeowners move to a new home and keep their original home as a rental property and have a management company make payments on the loan from the rent each month.
Now let’s look at some of the advantages an investor gets by buying properties subject-to.
• You don’t have to have good credit (or any credit) to do the deal. A new investor (or any investor) may not have the best of credit for many reasons. But bad credit shouldn’t keep a person from the opportunity of being a real estate investor. You are not applying for a loan, so your credit doesn’t matter.
• It’s fast! One of the most important things to a motivated seller is the speed with which you can close the deal and solve their problem. Once the seller has agreed to the subject-to deal, you still need a few days to do a complete home inspection and title search, but you can usually close within a very short time period. You won’t be waiting week after week for a loan approval.
• It’s cheap. There are no loan costs, no high points or interest from a hard-money lender, and there is no need to split the profits with a private lender or financial partner. Your only costs are normal closing costs.
• You may not need a down payment. If the seller just wants out and has little or no equity in the home, you wouldn’t need much cash to complete the transaction. If you were getting a new loan to buy the property, the bank (in today’s lending environment) would likely force you to put 20 percent (or maybe even 30 percent) down as an investor. The bank wants you to have your money in the game these days.
• You don’t have to have a job! Many lenders consider a full-time real estate investor as an unemployed individual, not a self-employed individual. The days of “stated income” and “no doc” loans are gone. Again, when buying subject-to, you don’t need a new loan.
• You can do unlimited deals without the fear of being cut off by the lenders because you own too many homes and loans.
• You can use the cash you have to do a lot more deals. In many cases, you can not only buy the property subject-to the existing mortgage, but you can also get the seller to agree to seller financing on any equity they might have in the property. Getting long-term seller financing is great, but you might also just have the seller carry the note for a few months until you get the property fixed and sold. This way, the original seller gets paid their equity when the home sells, and you conserve your cash for the rehab or for buying more properties.
• You can still borrow money on the home at some point if you need to. You own the property; you (or your company) have the deed. As long as the value of the property provides equity beyond the first mortgage, you could get a second mortgage if you needed to.
There are also advantages for the seller when they sell their property subject-to:
• They have a sure sale and don’t have to wait weeks and weeks to see if the buyer qualifies for a new loan.
• Because no new financing is required, the closing can take place very quickly and the sellers can get on with their lives.
• If the loan was in default or was about to go into default, the seller can potentially be saved from foreclosure and from the severe credit damage done by a foreclosure.
• When the investor buys a property subject-to the existing loan, if the loan was in default, the investor brings the loan current and takes over making the monthly payments. The seller’s credit only shows late payments, but no foreclosure. The seller’s credit will improve once the buyer brings the loan back in good standing and continues to make monthly payments. This is a big benefit for the seller, especially if they are considering buying another home in their future.
• Even though the loan and the loan payment will still show on the seller’s credit report, the seller can show the income from the property sale to offset the loan payment; the same as a seller could show rental income to offset a loan payment. Thus, the seller could still qualify for a new loan to purchase another home in the future.
• If a seller has some true equity in their home that they would lose in a foreclosure, they could set up an equity-sharing agreement with the investor and get cash out of their property when the property is rehabbed and sold by the investor. Again, without the investor, the seller would probably lose any equity they might have in their property.
Buying properties subject-to is a great way to buy properties with no credit and no down payment. Now it is up to you to decide whether or not buying subject-to is a technique you would like to use. Be sure to check the laws in your state to see if any restrictions exist on buying property subject-to.
And remember, if you buy a property subject-to, treat that loan as if it was one you had originated and had in your own name. Make sure all payments are made on time. You don’t want to put the original seller at risk or ruin their credit by missing payments. Plan your exit strategy in advance, and make sure you have money set aside to make the mortgage payments during the rehab period, as well as during the selling or lease-up period. If you default on a subject-to deal, your credibility and reputation will be jeopardized, and credibility and a good reputation are critical to your long-term success.
Now go out and make lots of offers!