Buying ‘Subject-To’ is one strategy I have used over the years to purchase real estate with very little, to no money down, without having to use a bank or get a lender for.
Did you know that you can purchase a house without having to pay the existing loan off?
This is called buying ‘subject to’ the existing mortgage. If a house has a mortgage on it, you can leave the existing loan in place (with the seller’s permission of course) and still buy the house as normal, transferring deed to your name (or your entity name).
The loan remains in the seller’s name but obviously you should be responsible for making the payment.
Before I go any further, I want to make a disclaimer: I am not an attorney or broker, and I would advise you to seek counsel from an AR real estate attorney before attempting this transaction.
But what about the ‘due on sale’ clause? Cant the bank call the loan due? The answer is Yes, they certainly can. When signing a loan (promise to pay) note with a bank, there is a clause in the note that states if the collateral (the property) is sold without paying them in full , then they have the rights to call the loan due in full . So you can see that it is important that both parties (buyer and seller) understand this.
From my experience, I have never had any bank call the loan due. As long as they are getting the payments, they don’t seem to care. But frankly, they don’t really know that a sale has even happened. This is especially true for the larger banks.
So with that said, I’ll share 2 things about this strategy. First, how you can structure them (what the purchase/sale transaction looks like). Next, what I look for when deciding when to buy a property subject to the existing mortgage.
How to structure a Subject -to purchase: (again, get some advice on this ) I will only share a brief summary of the structure. You can do things a little differently each time, etc.
1) First and foremost, I verify that my seller understands the structure and that they are ultimately responsible for their loan as it will remain in their name. I inform them of the risks on their end. (the violation of the due on sale clause, the fact that the loan is still in their name with no collateral, etc )
2) Obtain original note agreement (seller’s note payable to bank) and recent mortgage statement. You want to verify loan terms, PI payment breakdown, escrow balance and escrow breakdown, etc.. You want to verify the tax amount and if any credits are being applied to it, etc.. (watch out for homestead credit and senior discount) .
3) Sign purchase agreement and submit to escrow to run a title search (just like any other transaction). In your purchase agreement, write : subject to the existing mortgage , not to exceed (amount owed). See other agreements:
Other agreements section:
Subject to existing loan, where loan will remain in sellers name
Payoff not to exceed __
Payments not to exceed ___
(and any other agreements you want to add here)
4) Obtain insurance quote, and make sure your insurance company can add your seller as ‘additional payee’. Tell your insurance company there is an existing loan in place and they will need to submit the policy to the lien holder to replace the existing one . (this is when the insurance is escrowed into the mortgage payment , which most loans have this structured this way) Basically you still want to replace the existing insurance policy with one of your own. Often times this can save you money in premiums, hence lowering your debt service on the property.
5) Obtain access to the seller’s mortgage online account. Get the user and password so that you have control over payments, etc..
6) If the loan is past due , then get a reinstatement letter from the bank with the exact amount needed to bring it current, with a date that is on or after your closing date.
7) Close at the title company, bringing any funds to the table to close it. This could be paying for all closing costs, bringing in the loan current (reinstatement amount if loan is past due) , etc. The title company needs to know if taxes are escrowed into the existing loan so that they do not collect and prorate for the year (like normal).
8) Set up the method of which you will make the payments to the bank. (again, I like using the online account method) I also change the mailing address. The seller can also access the online account so that they can verify you are making their payment.
9) Perform your exit strategy. Rent, resell, or lease to own or owner finance.
BONUS: There is a way to hide ownership of the property by buying the property with a trust (aka land trust). One thing you can do is name the trust ‘seller family trust’ or ‘123 main st trust’. This can hide the fact that the property was transferred because it will look like the seller did an ‘in-house ‘ transfer from their name to their trust. Many investors buy all of their properties using trusts so that their assets are hidden from public record.
When to buy via subject to : (qualifications that makes a good investment for me )
Here is what I am looking for when deciding to purchase subject to:
-The loan is a good loan with a fixed interest rate. (no arms or balloons, etc )
-There is a minimum of 20% equity in the property. (and it better be in good shape or I want more equity than this)
-Minimum to no work needed (move in ready). The property could need some cosmetic repairs but nothing major. Heres an added tip: IF the property needs repairs and IF (BIG IF) there is enough equity to justify, you can use a private lender on a 2nd mortgage to fund your rehab expenses.
-Age of loan. I want to look at the principle / interest ratio and see how much principle is getting paid each month. The older the loan, the better this will be. This is one of the biggest bonuses to buying subject -to, you can take advantage of an aged amortization schedule by paying down the loan much faster, hence gaining equity faster.
-Minimum of $350 cashflow. I want the property to cashflow and its not worth it to me if it isn’t.
-Seller is easy to work with, and understands things clearly. I have to know that they won’t be bugging me to pay it off for whatever reason. And, I also have to know that I can always and am always wiling to pay it off if I have to (due on sale , or some other reason) Another thing about the seller being easy to work with: This also means that this strategy won’t harm them or affect them in the future. For example, if they need this loan to be paid off in order to purchase another home, then this strategy will not be good for them. Always structure your purchases where both parties have value.
Who would want to sell their property this way? Well, motivated sellers would. Here are some examples of situations I have used this with:
–Seller moved out of state, house didn’t show well and didn’t sell quick enough, owner facing potential loan default
–Owner was deceased, family inherited property and inherited the debt, didn’t want to deal with it nor make the mortgage payment
–Owner had property as a rental, tenant moved out, left it in poor shape (cosmetics) , didnt want to spend any more money on it but had a mortgage payment on it too, decided they’d rather let us take it over
How to profit when buying subject to:
Subject to purchasing is great when buying and holding rentals, because of the power of principle pay-down. Most of the time I buy properties that have 15-20 year old notes, and there is only 10-15 years left. The amortization schedule is at the 50% ratio level (50 principle / 50 interest) and can often times be past it.
One strategy I use is re-selling using a contract-for-deed, and I use this when I want to sell ‘as-is’. I create a spread on what I owe versus what is owed to me, and my principle pay down is happening much faster than my buyer’s. (because they are starting on a 20 or 30 year note)
I have often ended up selling outright to a retail buyer. Sometimes I would have to fix a few things or handle the objections in their inspection report, but it worked out just fine.
Buying subject to doesn’t really affect your exit strategy. In fact, it can amplify it for the better ;).
In the case that I need rehab funds to fix one up, I go and borrow from my private lenders and put them on a 2nd position mortgage. This note is typically very small and the equity % is still very safe.
Well, I hope this helps a little . If you’ve never bought with this method I do not mind assisting you in the transaction or talking things through with you . I am not an expert by any means but I have purchased about 15-20 using this method over the years.
**If you would like to buy using this method, we may can sell you some deals like this, where you won’t have to use a bank loan to buy. Just let us know 😉
P.S.: Check out these posts if this is the first you’ve read :
–Introduction to Seller Financing
–Seller Financing Series Part 1 : The seller carry back