Way back when, I used to have an “I Buy Houses” business. I would act as the bank for a few bird dogs who were steadily feeding me deals. In those days, “subject to” was one of my favorite strategies for buying properties from motivated sellers.
It was a very valuable tool for me back then, and I actually still use it today on a much grander scale. Notice I said it’s a tool of many that I utilize when dealing with a potential seller. If there’s anything that I’d like you to take away from this article, it is to use the right tool for the right job.
When I was aggressively looking and marketing for real estate deals, it wasn’t about what I knew how to do. I didn’t say to myself, “I want to learn how to do subject to deals and go out and look for them.” I learned about subject to (from the likes of William Tingle, Peter Conti, and David Finkel). Then I put that tool away in my arsenal to pull out when needed, along with my other tools — including cash offers (with private or hard money), owner financing, and lease options.
Like I said, there is a time to use and a time not to use each of these strategies. For example, if an owner owes more than a property is worth and it needs a lot of work, I’m usually not doing a subject to deal. Or if a lease option needs a good bit of work, I would not do the work without getting the deed.
What is “Subject To” Real Estate?
First of all, what does buying a house “subject to” really mean? After all, there are all types of subject to clauses one can put into a contract when buying a home. This includes subject to attorney review, buyers inspection, finding a quality resident (as in a lease-option), or as we’re referring to today, the existing mortgage.
In the beginning, this was a tough concept for me to understand. I wondered, “Could I really just take over someone’s mortgage payment on their original loan, and they’d transfer me the deed?”
The answer is yes.
Why Would a Seller Be Willing to Sell Subject To?
This was probably the toughest thing for me to get. Why wouldn’t the seller just sell the home? Why would they give up equity or title? Why would they jeopardize their credit?
As I did more deals and worked more with distressed sellers, I soon discovered the why. Unfortunately, bad things happen to good people, and sometimes they get themselves into tough situations or they just plain run out of time.
The first subject to deals I did were while I was practicing as a real estate agent. One was a single residence in a nice family neighborhood, and the guy wanted to retire to his vacation home in another state. The property needed a lot of work, and it looked like the hoarders had lived there. The seller and I had tried to sell it, but we just couldn’t get a good enough number for it. It was then that he agreed to sell it as a subject to deal to my contractor buddy. It turned out to be a win-win situation for everyone.
Subject To Advantages for the Seller
The seller was able to walk away and retire immediately. He didn’t have to wait to sell it, he didn’t have to clean it out, he didn’t have to fix anything, and he didn’t need a home inspection, a certificate of occupancy, or a termite report. He just took what he wanted and left. In fact, he didn’t even pay any Realtor fees or normal closing costs because I agreed to let him take it off the market since my contractor buddy would let me list the “pretty version” of the house.
In fact, the seller wasn’t even worried about the contractor paying on the mortgage since they both had access online to see if the loan payments were made. The contractor also had a history of doing these types of renovation deals in the past, and besides, the seller said he may never need his credit to buy another place in the future anyway.
Subject To Advantages for the Buyer
The advantages for the buyer were numerous, too. He was able to pick up the loan payments on a favorable spot of the amortization schedule (where the P+I payment is more P than I), and he got all of the tax advantages, low closing costs (similar to a cash deal with no lender points and fees, appraisals, etc.), a quick closing (but still needed title insurance), and a better interest rate (since it was an owner-occupied loan at origination). He didn’t need to qualify (it didn’t show on his credit), and he didn’t even have any personal liability on the debt. The beauty of it was he was able to get long-term financing without ever talking to a bank.
The Pitfalls of Subject To
By now you may be thinking, “What’s the catch?”
And you’re right. There are things to be cautious of (remember what I said about having the right tool for the right job?).
I referenced getting title insurance when purchasing a subject to deal because one risk is any existing liens. So, be sure to pull title and utilize a good real estate attorney in your state, especially for the first time around.
There are some additional pitfalls as well.
The Due on Sale Clause
There’s no doubt that the due on sale clause can potentially be one of the biggest pitfalls. This is a clause in the original loan documents of the seller. In essence, it says that if title is transferred or changes hands, the bank has the right to call the loan due and in full. Keep in mind, I said “right to call the loan,” but the real question is how often do they?
As someone who has done too many subject to deals to count over the years, largely due to foreclosing from a junior lien position, I can only recall one time where a bank would not allow us to reinstate a first mortgage (thus calling the mortgage due), and it was because they knew the borrower was deceased.
In another instance, I had a friend who took over a local home subject to, and she made it a rental property. The mortgage company sold the loan to a third party, and then the third party called the loan due since they had noticed that it had transferred hands and that there also was equity in the property. In this case, my friend just refinanced the property and paid the lender off. So it is good to be aware of this possibility and have reserves or access to cash if this situation should occur. But also keep in mind that the lender would have to take you all the way to foreclosure, and that’s usually plenty of time to sell or refinance the property (timelines vary by state).
In this type of situation, it wouldn’t impact my friend’s credit, but it could impact the seller’s credit. In this case, the original seller already had pretty banged up credit from a divorce, but that’s not the point. You really don’t want to make it worse if you can help it.
Another issue may be determining who should insure the property and if a change in the insurance policy would trigger the bank to exercise the due on sale clause.
The best advice I’ve gotten on this was from my buddy, Tim Norris (from the Affinity group), who said that the owner of the property must own the policy. Also, leaving the seller’s policy intact and just getting another one for the new buyer, thus having two policies on the property at the same time, is probably not a good idea since you might have a situation where both insurance companies would be trying to deny a claim if one were to occur.
It’s probably easier to have all parties named as insured or additional insured on the one policy, including previous and current owners.
The only other potential pitfall I can think of is if you should need a seller’s signature down the road. In my first example, my contractor buddy cleaned out the property and fixed it all up. I then got to sell the newly renovated property to a nice family. (Plus, I got to make an even larger commission than I would have if I had sold the property in “as is” condition for the original seller.)
The seller got to move out of state and enjoy retirement right away. But since the seller had moved far away, it was also good that my buddy had gotten the limited power of attorney from the seller, which enabled him to sign things on behalf of the seller in regard to the property. This became very relevant when things like the return of mortgage escrow check from the seller’s bank came in after the sale of the property.
As you can see, there are many advantages for the buyer of a subject to deal, beyond not needing hard money, as well as lifestyle and financial advantages for the seller. I strongly recommend adding this tool to your tool belt.