Subject-to deals offer real estate investors greater flexibility compared to traditional deed transfers. Read on to learn what this tricky term means and what to consider when entering into a deal.
Subject to is shorthand for a way to acquire investment properties without using the investor’s own cash or credit and only works in certain circumstances. It also has significant risks and limitations. Regardless, subject to financing is a technique every savvy real estate investor should understand.
Put simply, being a subject to real estate deal means that a homebuyer assumes responsibility for the seller’s mortgage payments.
In a subject to deal, a buyer takes over the seller’s loan payments. Before doing that, however, the investor negotiates a deal with the seller, giving the buyer legal title to the house.
The key difference with buying property subject to is that the buyer doesn’t get a new loan to replace the existing mortgage. The existing mortgage remains in the seller’s name. Instead, the investor is obligating himself to make payments on the existing loan. In return, the seller grants the investor title to the property. The language in the contract states the buyer owns the property “subject to” the claim of the holder of the existing mortgage. Hence, in real estate investing, it is called a “subject to” deal. In many ways, this is similar to any real estate purchase. The seller moves out, and the title of the property transfers to the buyer. The buyer can then sell it to another investor. Alternatively, the buyer can rehab it and flip it to an owner-occupant. Or the buyer keeps the property and rents it out for income.
Subject to enables an investor to acquire property quicker than a traditional purchase by avoiding the down payments. Advantages of owner-financed deals include:
Subject to letting a real estate investor do deals in much less time than he or she could using conventional means because the investor doesn’t need to use his own cash.
As a result, you can do many more deals. And because costs are lower, subject to also allows for more profit from each one.
Relatively few deals are done subject to. The reason is that there are significant risks to both the buyer and the seller.
For investors, potential risks include:
The lender is demanding immediate payment of the seller’s mortgage in full. Many loans have due-on-sale clauses requiring the loan to be paid in full when the property changes hands.
In practice, mortgage companies do not usually exercise this clause. But it is possible and could present a problem if the investor can’t easily refinance the loan.
The seller could declare bankruptcy, causing the mortgage to become tied up in bankruptcy court. Undisclosed liens assessed against the property won’t allow you to transfer title when the note is due.
Buyers may also not have enough cash flow to make monthly payments and may even get behind on their obligations. Properties that are too distressed make scaling harder because capital is tied up in renovations.
Sellers also face risks. If the buyer gets behind on the mortgage payments, the seller’s credit rating will be hurt, as the original loan still shows up on the seller’s credit report.
This means the seller is less likely to get another loan to purchase more property. Keep in mind that lenders are skeptical of borrowers with poor credit scores.
The first challenge with subject to is finding a suitable deal. Not every investor, property, or seller is well-suited to this investor’s tool. The main requirement is finding a motivated seller.
These sellers are usually distressed; they need to sell the property, and there is some constraint. Here are some of the types of motivated sellers.
While sellers in subject to deals are often distressed, they can be too distressed. If they get too far behind on payments and the property goes into foreclosure, a subject to deal probably won’t work.
The subject to language in the contract with the seller is critical. It’s essential to have a real estate attorney look over the contract. The attorney should review other terms of the deal as well.
Different states have different rules about subject to, and it’s important to follow the letter of the law. Although there won’t be a conventional closing to complete the transfer of ownership, the investor should get a title policy.
This will protect against the possibility of other existing lien holders having a claim on the property. To protect both buyer and seller, the investor should arrange for a title company to collect and send in the mortgage payments.
This will make sure the loan stays current and the seller doesn’t get a negative mark on his or her credit rating.
There are many ways for an investor to exit a subject to real estate deal. These include:
Basically, you can use just about any exit strategy you’d use if you acquired the property conventionally. This includes rehabbing, renting, leasing-to-own, etc.
Subject is not suitable for every property or every seller. It has significant limitations and risks, and it requires great care. This means you should consult an expert for their advice. Real estate attorneys make excellent advisors in these matters.
But subject to deals allow investors to acquire property quickly, easily, and with little cash outlay. While not without risks, this type of own financing is one that every astute investor should understand.
Have you ever done a subject to real estate deal? Let us know about it in the comments section below!
