Existing Loan Stays In Place – No Liability To You!
“In order to carry a positive action we must develop here a positive vision.” ~ Dalai Lama
A Subject-To deal simply means that you get the deed/title to a property and take control over the property. The existing loans stay in place in the original homeowner’s name, negating the liability to the purchaser. The mortgage is not being paid off through a Subject-To contract transaction, just taken over by the purchaser. As long as the purchaser of a Subject-To deal makes the mortgage payment to the existing mortgage lender, there are no consequences to either party. However, if the purchaser stops making the payments on the mortgage, the seller’s credit will be damaged.
Most sellers are in a situation where they may have to relocate quickly, have no equity in the home and just “want out,” or are about to go into foreclosure and want to save their credit. These folks are motivated to sell on a Subject-To deal to get the payments caught up (or maintained) and stay on time to help their credit.
One reason you would purchase on Subject-To is to utilize a seller’s lower interest rate than that is on the market at the time. For instance, if the market rate is 7% and a seller has a 5% fixed rate, the 2% difference can make big difference in your monthly payment. You are able to purchase the home in a 7% market at 5% interest! For instance:
Perhaps you don’t qualify to buy a home. A Subject-To purchaser doesn’t have to meet a bank’s rigid standards. Closing costs and down payments are typically lower and there will likely be more flexible payment terms. Also, establishing escrow and insurance is unlikely.
How does it work? There are three typical ways to do a Subject-To deal:
Straight Subject-To Cash-To-Loan
The purchaser pays the different between the purchase price and the seller’s loan balance. If the sale price is say $200,000 and the seller owes $150,000, the purchase pays the $50,000 difference in cash.
Subject-To with Seller Carryback
As an example, the sales price is $200,000 and the seller owes $150,000. The purchaser makes a down payment of $20,000 and the seller carries the $30,000 as a second mortgage with a separate interest and terms. The purchaser would make a one-time payment to the mortgage company of $20,000 and pay the other $30,000 through the owner-held interest and terms, effectively a second mortgage to the purchaser.
In this instance, the seller is given an override of interest because they are making money on the existing loan balance. For example, if the sales price is $200,000, the existing loan rate is 5% and the purchaser puts down $20,000, the seller’s carryback is $180,000. At a 6% rate to the purchaser, the seller makes 1% on the existing $150,000 mortgage and 6% on the $30,000 balance. The purchaser is paying 6% on the $180,000.
Here’s the best part–a purchaser can purchase as many Subject-To deals as they want – there is no limit to how many properties can be owned at one time through Subject-To! There may be a property that needs a lot of work and the owner may have little equity in the mortgage. Provided that the market conditions are right, through a Subject-To, you can purchase the property, make the improvements, and then sell it for a profit. A Subject-To is also appealing for an investor to lease/option properties creating monthly income, including the deposit for move in and then a profit when the property sells.
Perhaps there is a reluctant seller that wants to sell on a Subject-To but is nervous about the purchaser’s attention to the property and ability to pay on time. The seller may offer the purchaser a lease/option for 6-12 months to see how it goes and then proceed with the Subject-To.
As you can see, there are several reasons a seller can be motivated to a Subject-To deal as well as several different benefits for a buyer. But there’s always a caveat. With a Subject-To deal, the lender is not made aware of the transaction. The purchaser just makes the payments to the mortgage company no harm, no foul. However, there is usually an acceleration clause in a mortgage and trust deeds that give lenders the right to “accelerate the loan in the event of alienation.” Typically, the lender is just happy to receive the monthly payment on time, but they do have the right to exercise the acceleration clause, creating some risk for the purchaser. If the purchaser can’t payoff the outstanding loan on the bank’s demand, the property could go into foreclosure. Again, this usually does not happen in today’s market. In the past when interest rates were higher, lenders had a great reason to “call the loan.” Today, the last thing a bank wants is another foreclosed property. The key is to keep the property in good condition and make the payment on time.