Learning about subject-to real estate is an essential step in real estate investing. These properties are an excellent source of investment capital. But finding them can be tricky since they generally don’t appear in the MLS or on the internet.
If you are looking to expand your real estate investment portfolio with a limited budget, you can always go the traditional route and purchase a distressed property. But many of these properties require repairs and upgrades, which can take a long time and cost money.
This guide will help you learn how to find subject-to properties for your next real estate deal.
What is a Subject-To Property?
A subject-to property is a property that is subject to an existing mortgage. Investing in a subject-to property involves purchasing a property still covered by the initial mortgage. Instead of paying off the existing mortgage, the homeowner transfers the payments to the buyer.
How Subject-To Deals Work
In a subject-to transaction, the buyer assumes the homeowner’s mortgage obligations without officially informing the lender. However, the existing debt remains in the homeowner’s or seller’s name. While the mortgage remains in the homeowner’s name, the buyer receives the home’s deed and must make mortgage payments on schedule.
A subject-to clause commits the buyer to make payments to the seller’s mortgage company until the loan gets paid in full. But the seller’s name remains on the mortgage even after the buyer has paid off the mortgage.
The homeowner often keeps the remainder of the sale money while the buyer typically pays down the outstanding mortgage. Alternatively, the buyer may shoulder the responsibility of the remaining mortgage through a procedure known as mortgage assumption. A compromise between the two is called “subject-to.”
Subject-to transactions can get pretty complex. The terms on the existing mortgage debt may affect the success of a deal, so you’ll need all the help you can get. The Mortgage Shop (TMS) can help you seek the best mortgage options and navigate even the most complex situations. Contact TMS for consultation and expert advice.
Subject-To vs Mortgage Assumption
The primary difference between a subject-to and mortgage assumption is in the formality of the agreement, but it also covers other areas.
In a subject-to deal, the mortgage lender doesn’t get notified of the agreement. Most lenders have no problem with this arrangement as long as the mortgage gets paid off when it’s due. However, some lenders may enforce a due-on-sale clause if they find out about a subject-to real estate deal.
However, mortgage assumption involves taking over the debt and a formal agreement with the lender. The seller’s name gets struck off the mortgage, and the buyer’s name replaces the initial homeowner’s name.
Most traditional mortgage lenders do not offer mortgage assumptions. That’s one of the perks of investing in subject-to real estate. However, some government loan programs offer mortgage assumptions for investors interested in this investment opportunity.
Types of Subject-to Deals
There are three models or structures for subject-to sales. In some cases, a subject-to deal is a component of owner financing for the average homebuyer. However, real estate investors usually have it differently.
Below are the three examples of subject-to structures:
Basic Cash-to-Loan
In a simple cash-to-loan subject-to, the investor or buyer gives the seller cash for the difference between the agreed-upon purchase price and the seller’s existing loan balance.
This subject-to structure is the most straightforward and widely-used. As an investor, you must pay the outstanding mortgage loan up front when purchasing the property.
Cash-to-Loan Deal Illustration
Let’s say you buy a property at $280k, and the existing mortgage balance is $220k. When you purchase the home, you will pay the original homeowner $60K ($280k – $220k) in addition to the purchase price (280K) in cash. That means you’ll pay $340K in total.
Using this structure, the investor doesn’t have to take over the mortgage, as in a mortgage assumption. They only need to pay a part of the mortgage so the seller can cover their outstanding debt.
Seller Financing or Carryback
Seller financing, also called seller carryback, is similar to getting a second mortgage in specific ways. This structure is similar to the first one, but the homeowner covers the investor’s outstanding cash payment in this case.
This structure may be the only viable option if the buyer cannot fully finance the difference between the purchase price and the existing mortgage debt.
Seller Carryback Deal Illustration
So, let’s say you want to purchase a home for $280K but don’t have up to $60k to finance the mortgage. Let’s say you can put down only $40k.
The seller will provide you with a $20K “loan” from the $60K you are supposed to pay. When you pay the lender the $220K debt in full, you’ll also have to pay the seller back for the $20k loan.
In a seller carryback deal, the seller merely permits the buyer to make installments over a brief period rather than giving the buyer cash. The buyer and seller agree on the terms, like a down payment for both the carryback loan and purchase price and interest rate. Additionally, the investor must pay off the purchase within five years or less.
A Wrap-Around Subject-To
In this subject-to structure, the seller offers owner financing that “wraps around” the existing loan balance. While this structure appears similar to a seller carryback, it isn’t. The interest rates in this subject-to type are usually higher and depend on the rate for the original mortgage.
In a wrap-around deal, the original homeowner typically makes a profit from charging a higher interest rate than the existing mortgage. For instance, a homeowner may demand an 8% interest on the seller-financed loan while the existing mortgage charges 6%.
Wrap-Around Deal Illustration
From the illustration above, the home’s purchase price is $280k, and the existing mortgage debt is $220K. The buyer puts down $40k and gets a $20k loan from the seller.
The seller provides a $240k seller-financed loan to the buyer in a wrap-around subject-to { $280k (the purchase price) – $40k (buyer’s down payment)}.
The seller continues making mortgage payments while receiving one payment from the buyer.
If the seller is paying 6% interest on their $220K mortgage but charges the buyer 8% interest on the seller-financed $240K loan, they keep 2% of the payment that their original lender receives. Also, they keep the complete 8% on the $20K portion that’s fully seller-financed.
How To Find Subject-to Real Estate Deals
If you’re a real estate investor who’s looking to find a way to generate more income, you’ve probably considered investing in a subject-to property. In theory, these deals are great, but they can be challenging to find.
The following tips can help investors learn how to find subject-to properties and get the best deals.
Properties in Distress
One of the best ways to find motivated sellers is by locating distressed properties. This nontraditional technique can be pretty productive since many homeowners have properties in distress.
The most robust options for subject-to sales are distressed property owners who lack the funds to perform the necessary repairs. Offering a subject-to deal to a homeowner with a distressed property can help them salvage their situation without harming their credit. Discuss the possibilities with them and agree on terms that will favor both parties.
Mail-order Catalogues
Conducting a direct mail campaign with prospective sellers as your target audience is another technique to locate subject-to properties. Some homeowners facing foreclosure or distressed properties do not know about subject-to sales.
You can send numerous emails with your contact information to specific communities and follow up on every potential lead. Additionally, you can rely on your real estate network to inform you about any distressed properties or homeowners looking for a quick sale.
Benefits of Subject-To Deals
Are subject-to real estate transactions worth it? In short, yes. The real estate investor and the seller can gain from a subject-to sale. And below, we’ll highlight the benefits of deals like these to investors and sellers.
Benefits To The Real Estate Investor
— Cost-Effective
Subject-to deals are typically less expensive upfront and at closing, because there are traditional loan agencies or loan officials involved. Even if you don’t have enough cash for upfront settlements (like down mortgage payments), you can navigate the situation with a carryback or wrap-around deal.
— Easier Purchases
Investors can take advantage of subject-to deals even with less-than-desirable credit. If you understand how conventional loans work, you know that you may not qualify for financing with bad credit. But subject-to deals make it possible to purchase real estate without conventional loans.
— More Rapid Equity/Income
Since you pay off a portion of the mortgage balance when you buy a subject-to property, you’ll gain home equity relatively rapidly. A subject-to sale also concludes considerably faster than regular mortgage transactions, making them more suitable for house flipping.
Benefits To The Seller
— As-is Sale
In a subject-to sale, buyers frequently acquire property in its current state. This perk can be helpful if the homeowner has to sell their house quickly or doesn’t have the funds to pay for renovations.
— Redeeming Features
Some homeowners sell their homes to raise money quickly, either because they are going through a foreclosure or have experienced a significant life tragedy. A subject-to deal can be a saving grace for these homeowners.
— Limit closing expenses
Sellers are sometimes exempt from paying closing expenses in subject-to sales. This exemption can assist them in lowering the selling costs and significantly lessen the stress involved in the transaction.
Risks Involved in Subject-To Deals
Subject-to deals are a great way to get a great deal on a property. However, they can be tricky to navigate and are not for everyone. The risks are unique in their own right and must get weighed against the benefits.
Risks for the investor
— Speeding Up Loans
The lender may retain the right, following various agreements, to demand an early total payback or accelerate the loan’s maturity date.
— Insurance
Homes obtained through subject-to deals aren’t easy to insure.
— Foreclosure
It is simple to overestimate your financial preparedness when purchasing a property without a traditional mortgage. You may underestimate the implications of paying a seller and a lender separately.
Risks for the seller
— Liability
While the buyer owns the house and has equity, the seller is still responsible for the mortgage. The seller might face foreclosure if the buyer doesn’t pay off the mortgage. This will affect the seller’s credit score negatively.
— Due-on-Sale Clause
When you sell the house, some mortgages’ due-on-sale clauses require you to pay down the outstanding balance. While most lenders frequently choose not to enforce this clause, specific lenders might. You won’t receive interest on the buyer’s mortgage payments if you’re required to pay off the balance when you sell the property.
A Few Pointers for Real Estate Investors
Learning how to find subject-to properties is essential to every investor interested in growing their real estate investment portfolio. But some tips can help investors avoid costly errors and make the most out of every deal.
Work With A Real Estate Attorney
While a subject-to deal is perfectly legal, the regulations governing these transactions tend to differ between states. Their contracts also vary by state. So it’s essential to have knowledgeable real estate experts by your side who are familiar with state regulations and can advise you at every stage of the procedure.
Examine the Rental Property
Before investing in rental property, you should assess your total cash outlay and the property’s after-repair value (ARV). Think of it as a vacation rental investment or any other investment property. If you intend to rent out the property, you must determine its future income and expenses to determine if it will generate cash flow and help you build passive income.
Study the Mortgage Payments
Before purchasing any property, you should always do your research. In this case, carefully review the loan terms. There may be unstated terms and provisions. Check whether the interest rate is set or adjustable and if provisions have been made for taxes and insurance.
The Bottom Line
Buying a home is a wonderful investment, and if you can find an existing property that you can buy for less than the market value, you can save a ton of money.
Finding great deals is what makes the business so fun. But that doesn’t mean you must scour the entire city for them. You can find great deals by just driving by a few of the houses in your neighborhood. Before you invest in a subject-to property, ensure you do your research and make sure that it’s right for you.
The Next Step
You may not know how to find the best deals, or you may not have sufficient capital for your investment plan. But you can get all the help you need at The Mortgage Shop.
The Mortgage Shop offers flexible, innovative mortgage options to suit your unique needs. Schedule a consultation call today!
