Subject To Transactions

Definition and Overview

"Subject to," or "subto," is a creative financing method where an investor takes over the seller's existing mortgage payments. Instead of the buyer obtaining a new loan, they purchase the property "subject to the existing financing." The investor makes the payments on the seller's loan, and the original loan remains in the seller's name.

Benefits and Advantages

• For the Seller: The seller can walk away from the property knowing the payments are being made, insurance is taken care of, and they have no further responsibilities.
• For the Buyer: The buyer can acquire a property without having to qualify for a new loan.

In-Depth Definition

Subject To involves taking over someone's mortgage or lease payments. This strategy is typically used when the seller has no equity in the property. The seller's leverage in this situation is the interest rate they have secured on their loan. The buyer takes on the payments and the interest rate of the original loan. It's a way to purchase a property by making payments on the existing financing rather than obtaining a new loan.

Calculations/Formulas

While "Subject To" transactions are primarily about taking over existing financing, the following general real estate investing rules can be used to assess the overall profitability of the deal:

• The 2% Rule: This rule helps to quickly screen potential rental properties. It states that the monthly rent should be at least 2% of the purchase price. For example, if a property is purchased for $100,000, the monthly rent should be at least $2,000.

• The 50% Rule: This rule helps to estimate the profitability of a rental property. It suggests that, on average, 50% of the income a property generates will be spent on operating expenses (excluding the mortgage payment). These expenses include taxes, insurance, utilities, repairs, and vacancy.

• The 70% Rule: This rule is often used by house flippers and wholesalers to determine the maximum allowable offer (MAO) for a property. It states that an investor should pay no more than 70% of the after-repair value (ARV) of a property, minus the cost of repairs.

Step-by-Step Implementation Process

1. Find a Motivated Seller: The first step is to find a homeowner who is motivated to sell their property, often due to financial distress (e.g., facing foreclosure) or a need to relocate quickly.
2. Due Diligence: The investor must conduct thorough due diligence on the property, including researching the title, the condition of the property, and the terms of the existing mortgage.
3. Negotiate the Agreement: The investor and the seller negotiate the terms of the "Subject To" agreement. This includes the purchase price, any down payment, and the timeline for taking over the mortgage payments.
4. Sign the Contract: A legally binding contract is signed by both parties, outlining the terms of the agreement. It is highly recommended to have a real estate attorney draft or review the contract.
5. Close the Deal: The investor takes over the property and begins making the mortgage payments to the seller's lender. The deed is transferred to the investor, but the mortgage remains in the seller's name.

Types of Subject To Deals

• Cash-to-Loan Subject To: The investor pays the seller the difference between the property's market value and the outstanding mortgage balance in cash.
• Subject To with Seller Carryback: The seller finances a portion of the purchase price for the investor.
• Wrap-Around Subject To: The investor pays a higher interest rate to the seller than the rate on the original mortgage. The seller pockets the difference.

Compliance Requirements

• Written Agreement: All terms of the "Subject To" deal must be in writing to be legally enforceable.
• State Laws: Investors must be aware of and comply with all state and local laws governing real estate transactions.
• Legal Counsel: It is essential to consult with a qualified real estate attorney to ensure that the transaction is structured correctly and that all legal requirements are met.

Warnings and Risks

For the Buyer/Investor

• Due-on-Sale Clause: The biggest risk in a "Subject To" transaction is the "due-on-sale" clause, which is present in most mortgages. This clause gives the lender the right to demand full payment of the loan if the property is sold or transferred. While lenders do not always enforce this clause, it is a significant risk.
• Loss of Home: If the lender enforces the due-on-sale clause, the investor could lose the property through foreclosure.
• Insurance: Obtaining homeowner's insurance can be more difficult for a "Subject To" property.

For the Seller

• Credit Damage: If the investor fails to make the mortgage payments, the seller's credit score will be negatively affected. This is because the mortgage is still in the seller's name.
• Liability: The seller remains legally liable for the mortgage until it is paid in full.
• Loss of Home: If the investor defaults and the lender forecloses, the seller will lose their home.

Best Practices

For the Buyer/Investor

• Thorough Due Diligence: Conduct comprehensive research on the property, the title, and the existing mortgage.
• Get Everything in Writing: Ensure that all terms of the agreement are clearly documented in a legally binding contract.
• Obtain Insurance: Secure homeowner's insurance to protect the investment.
• Work with Professionals: Consult with a real estate attorney and a title company to ensure a smooth and legally compliant transaction.

For the Seller

• Work with a Trustworthy Investor: Vet the investor thoroughly to ensure they are experienced and have a good track record.
• Get Everything in Writing: Ensure that all terms of the agreement are clearly documented in a legally binding contract.
• Understand the Risks: Be fully aware of the risks involved, particularly the potential for damage to your credit score if the investor defaults.

Common Mistakes to Avoid

• Not Researching the Existing Mortgage: It is crucial to thoroughly review the terms of the seller's existing mortgage, including the interest rate, the remaining balance, and whether it has a due-on-sale clause.
• Failing to Get Everything in Writing: A verbal agreement is not legally binding. All terms of the "Subject To" transaction should be documented in a written contract.
• Not Using a Reputable Title Company: A title company can help to ensure a smooth closing and that the title is transferred correctly.
• Not Having a Plan for the Due-on-Sale Clause: While the due-on-sale clause is not always enforced, it is a real risk. The investor should have a plan in place in case the lender calls the loan due.

Real-world Application Scenarios

• A homeowner facing foreclosure: A homeowner is behind on their mortgage payments and is facing foreclosure. They can sell their home "Subject To" to an investor, who can then take over the mortgage payments and save the home from foreclosure. This allows the homeowner to avoid the negative impact of a foreclosure on their credit score.
• An investor who wants to acquire a property with a low-interest rate: An investor finds a property with a low-interest rate mortgage. They can purchase the property "Subject To" and take advantage of the favorable financing.
• A seller who needs to relocate quickly: A homeowner needs to sell their home quickly due to a job relocation. They can sell their home "Subject To" to an investor, who can close on the property much faster than a traditional buyer.