A “subject-to” offer simply means that the buyer is willing to purchase a piece of property “subject-to” some specific circumstance. Usually that circumstance will be the sellers existing mortgage. It can also be a variety of other things.
One of the most common “subject-to” clauses in real estate contracts is “subject-to” buyers inspection. But for real estate investors, the most common use of the term “subject-to” is in relation to purchasing a property “subject-to” the sellers existing mortgage. This means that at closing, the property is titled in the buyers name, but the loan is still in the sellers name. Therefore, you are buying the property “subject-to” the sellers existing mortgage payments.
What are the advantages of “subject-to”?
The biggest advantage is that you are buying without the need to qualify for a new loan. When you purchase a property “subject-to” the existing mortgage, the seller is agreeing to allow you to take possession of their property, and pay their existing mortgage payments. Since you are not qualifying for a new loan, and the existing loan is in the sellers name, it is the sellers credit that is at risk, instead of the buyer. This means that a buyer can buy the property without having to worry about having good credit.
Why would a seller agree to allow someone to take over a loan that is still in the sellers name?
There is definitely some risk involved for a seller who agrees to sell a property “subject-to” the existing mortgage. For one thing, if the buyer decides to walk away from the deal, or fails to make the mortgage payments, the seller is the one who will suffer. A seller’s credit rating could be ruined by a buyer who fails to make the mortgage payments on time. Therefore, most sellers are very reluctant to agree to “subject-to” terms unless they are highly motivated to do so.
Seller motivation is the most common reason why a seller will agree to this type of arrangement. There is usually some extreme circumstance or personal issue that is forcing the seller to do something they might not ordinarily do. But in today’s market, with so much competition on the selling side, it’s easier than ever to find sellers who are motivated to do whatever it takes to sell their property.
I once did a “subject-to” deal with a seller who was getting married and moving out of state. She had been trying to sell her property for several months, with no takers. It was in a great area, in a nicer neighborhood, but the house needed some updating and the colors were rather drab inside.
Time was running out. The wedding was only weeks away, and the seller was planning to take up residence with her new husband in his house. Because of this she was motivated to sell the property any way she could.
She accepted our offer to buy her property subject-to the existing mortgage, for two years. That meant that we had two years to get new financing and pay off her existing mortgage. She understood the risk to her credit and was concerned, but we were able to produce references and other documentation that made her feel comfortable doing this deal. Had she not been in the position she was in, she likely would never have agreed to accept a sale that would leave the mortgage in her name, so motivation and a looming deadline were the primary factors.
We updated the house, and sold it a few months later to a buyer who was able to qualify for their own mortgage, so the seller got her money about a year and a half earlier than expected.
We had planned to lease/option the property to a buyer if necessary, then help them get qualified for a new loan. As it happened, we did not need to do the lease/option to get a buyer. Of course, we did spend some money fixing the property up first. This helped us find a qualified buyer faster than anticipated.
The “subject-to” arrangement allowed the seller to solve her immediate problem. It also allowed us to buy the property without having to qualify for a new loan. Everyone was happy.
Another time, I did a deal with an investor who sold to us “subject-to” an existing mortgage on a multi-unit property. He was motivated to get out from under the payments on this property due to some other financial problems he was having.
When writing “subject-to” offers, you need to get the seller to provide you with a copy of the current mortgage terms. You will want to include these terms in your offer, so that they are spelled out to the letter.
“Offer price $105,000 dollars, subject-to existing mortgage payoff of $95,780, with payments of $789 per month, principal and interest, (the seller’s current payment) interest rate 5.5%, for 24 months. After 24 months, buyer will obtain new financing and payoff existing mortgage balance. Buyer also agrees to pay seller $5,000 cash down payment”.
So we are going to carry this note for up to two years, and when we either sell or get new financing, we will pay off the sellers existing loan, and we will pay the seller $5,000 in cash, which helped the seller solve their immediate financial problem.
24 months is used in this example, but of course, your terms and time frame will vary with each deal.
You can put in any terms you and the seller agree to. It just depends on the situation and the level of seller motivation. Just keep it legal and moral. You can’t enforce terms in a contract that are in violation of existing laws, or attempt to circumvent legal procedures that are required by law.
If the seller’s payment also includes an amount for taxes and insurance, you would want to specify that too. You want to be sure you clearly document the exact terms of the existing mortgage. You will usually need your own insurance in your name, since you are the title holder of record, even if the mortgage is in the sellers name. Discuss this with your closing attorney or title company. to be sure you handle this correctly.
The payment and interest rate are taken directly from the sellers existing loan terms. You are merely documenting those terms in the offer, so that you are clear on how much you are paying each month. If there are additional arrangements, such as a second mortgage, or other terms you and the seller agree to, you should make sure that they are also clearly documented in the offer.
Writing a good offer is really just a matter of making sure every specific detail of your agreement is stated in terms that are clear to both parties. Should you ever wind up in court over contract, a crucial issue will be the clarity of the terms in the agreement.
You may want to have your attorney review the terms of an offer before you and the seller sign it, to insure things are correctly stated. It is pretty basic stuff, but if you need advice, get it BEFORE the seller accepts your offer. Don’t risk making a mistake if you are not sure how to word your offer. This article is not intended to be a substitute for legal advice.
As with any deal where you are taking over the payments, you want to be sure that your exit strategy will work with this existing mortgage.
For example, if you agree to buy a property subject-to an existing payment of $925 per month, and hold it for rental, be sure the rent will be higher than the payment and expenses. This sounds like a no-brainer, but sometimes people get so caught up in the idea of buying property without having to qualify, that they forget to make sure that the numbers make sense. If you are paying $925, but the property will only rent for $875, that ain’t such a great deal is it?
Just because you can buy a property “subject-to” does not mean you should. Make sure the numbers work for the exit strategy you intend to use. If you are going to fix and resell, you should check comps and be sure you can sell for an amount that is higher than the payoff on the existing loan. Don’t forget to include all of your anticipated expenses.
Your offer price plus all repairs and expenses should not exceed 80% of what you know the property is worth. (Note I did not say what you “think” the property is worth) You must double check and be absolutely as sure as you can be. Pay for an appraisal if you must, but the estimate of value has to be right. I have suffered the consequences of that myself. It is an easy mistake to make, even when you THINK you know.
Use 80% LTV as a general benchmark to judge your deal numbers. If total cost is above 80% of the after repair value, the deal gets less and less do-able. At 80% of ARV, the cash flow is generally positive and there is enough margin to produce at least a 10K profit. The farther below 80% you can get, the better. This is a good rule of thumb for those who are buying to hold for rental or retail. It gets more difficult to break even if you get too far above 80% of the market value.
Closing a subject-to deal is like closing any other deal. Paperwork will usually include a document that the seller will sign, which will be sent to their mortgage company. It will notify the lender that the seller is now assigning management of this property to “xxx management company”. It will also direct the lender to send all correspondence related to this property to the management company address. This may vary in your state. Discuss the details with a competent real estate attorney.
There is a long standing argument about whether “subject-to” deals trigger the “due on sale” clause commonly found in virtually all mortgages these days. This due on sale clause says that the lender can call the loan due if they find that the title of the property has changed hands without their knowledge.
There are many people on both sides of this argument, but to be honest, this is a change of title without the lenders direct knowledge, and in my opinion, this does give the lender the right to invoke the due on sale clause. If the lender did call the loan