In recent years buying property subject-to the existing mortgage has not been a “mainstream” strategy for real estate investors. Even so, it is a perennial favorite with “no cash no credit” buyers who want to buy a home but cannot or do not wish qualify for a traditional mortgage loan.
Prior to the housing market crash, new loans were relatively easy to get, and interest rates were low, so there was little incentive to purchase a property by taking it over “subject-to the existing mortgage”. This strategy is pretty simple at it’s core. A buyer takes over the sellers existing mortgage payments. The deed shows the new buyer as the owner, but the mortgage note remains in the name of the seller(s). If the buyer fails to make the payments or defaults, the seller must make the payments or risk damage to their credit.
Subject-to is popular with buyers because they do not have to qualify for a loan, and there is no credit risk for them personally. Sellers may be willing to allow a buyer to take over their existing mortgage because of various factors that motivate them.
I once purchased a property subject-to the existing mortgage, from a home owner who was getting married and moving to another city. She had been trying to sell the home through an agent for 6 months and the wedding was now only two weeks away. This motivated her to seek out an investor buyer who could solve her problem.
The property was in a good location, had around $35,000 in equity, and her mortgage payment was lower than market rent. The house needed about $10,000 worth of cosmetics to get into good retail condition.
We offered her $5000 cash at closing, to give her some money to move and get married, and we took over an existing payment of about $800 per month. If necessary we knew we could rent it for around $1200 per month, so we had a plan B to rent if we could not sell it.
The agreement called for us to make her payments and leave the existing mortgage in her name for 18 months. At that time we would have to refinance the property and pay her loan off if we had not sold it before then. She was OK with the idea of having this mortgage in her name for a few more months, but not long term. Sellers will vary on this point. The main thing for us was that we had 18 months to update the house and get it resold at a profit.
At it turned out, the rehab cost about $8K to give the house an interior facelift and brighten it up with newer, lighter colors. We sold it to a new buyer who got a new loan. We paid off the existing mortgage and made about $18,000 profit in just under 3 months. It was a win-win. The seller got married and avoided making a burdensome mortgage payment on an empty house, we got a great property with very little up front cost, and the new buyers got a very nice home in a great location for about 5K below the appraised value. Everyone was happy.
This strategy worked well in this case because of several fundamental issues:
1. The seller had a strong motivating factor, (getting married), with a looming deadline, (the wedding date), that had to be met. This circumstance was a strong fundamental issue in our favor.
2. The rehab was relatively simple and location was good. This helped keep costs down and allowed for strong demand from qualified buyers who liked that area. The job base was also very good at the time, giving us more potential buyers who could get a new loan.
3. The property had enough equity to allow for a profit on the resale.
4. The mortgage payments were low enough to allow for a positive cash flow if we had to rent the property, allowing for a back up plan if we could not sell the house for some reason.
I believe that market fundamentals will swing drastically in support of this strategy if interest rates were to begin to rise significantly. The tight-credit scenario in place now is already motivating more would-be buyers to consider this strategy as an alternative to getting a new mortgage. The U.S. taxpayers, via FHA, VA and USDA insure 90% of the mortgage market now, and the Fed is now buying $40 billion worth of mortgage backed securities each month. We are now dependent on the Federal Government and the Federal Reserve to fund the majority of the mortgage market, or interest rates could rise dramatically in a short period of time, while reducing access to new capital to fund the mortgage market.
To put it more simply – The fundamentals imply that subject-to could become the hottest strategy on the planet for buying and selling homes.
Given the past 10 years of very low interest rates, existing mortgages at 4% would be a hot item in a market where a new mortgage is going for 7%. In the 1980’s interest rates were above 15%. It has happened before and it could happen again. Rising interest rates would be a major fundamental development that would lead to wide spread use of the subject-to strategy by buyers and sellers.
Donna S. Robinson is a 17 year real estate veteran, with a special emphasis on real estate investing fundamentals and strategies. Follow her on twitter @donnaconsults and read her real estate investing blog.