Subject-To: A Key Buying Strategy for Today’s Market

The current post-boom market – in addition to freeing up a lot of loft apartments on the Upper East Side – has left the country with a lot more sellers than buyers. And for those without a great deal of capital looking to dip their toes into real estate investment, this imbalance offers some pretty ripe opportunities to enter the market.

The country is filled right now with “motivated” (read: desperate) sellers looking to get out of mortgages they can no longer fulfill. Which is where Subject-To deals come in.

Subject-To purchases are far more common than people tend to think. Subject-To, or Sub2, as it’s often called, is a completely legal arrangement in which a seller gives you the deed to their property in exchange for your taking over the mortgage payments.

The mortgage remains in the seller’s name, but it becomes your responsibility to make the payments to the servicer of the loan. In other words, you are getting the property “Subject-To” the remaining mortgage payments.

For Investors

Subject-To deals open the real estate playing field significantly for buyers who don’t don’t have a lot of capital on hand. (See: Ten Venture Capitalists and Their Secret FICO Scores). For one, these deals don’t require you to use your own credit, and allow you to pay back the mortgage at the existing interest rate, which will often be lower than the rate on a new mortgage.

Subject-To deals also allow investors to use seller financing to have the existing owner finance the transaction. This arrangement can be beneficial for both the buyer and the seller in a number of ways.

As an investor, a Subject-To deal allows you to:

1. Maintain an attractive interest rate if one already exists on the home

2. Avoid having to qualify for a loan

3. Maintain much more control over their investment

4. Avoid taking on another mortgage if there are already too many in the investor’s portfolio

5. Readily achieve the ideal goal: acquiring equity.

For Sellers

So what’s in it for the seller? Quite a bit, as it turns out.

Firstly, you can charge your buyer a non-refundable owner financing fee. Then, before they begin to make payments, you can mark up the original interest rate to generate some passive monthly income. When it comes time to sell, if the property goes for more than the loan amount you took on, you’ll collect the difference when the buyer refinances the mortgage down the track.

By signing the deed over to you, and having you bring the mortgage payments current, the seller is saved from having to foreclose, and the black mark that leaves on their credit history. Subject-To is also easier for the buyer than a traditional sale: there are no banks involved, which means no lengthy delays and hefty closing fees. In the current real estate market, many owners need to sell quickly, but have trouble finding a buyer. With a Subject-To deal, the seller can get the deal done quickly and move on.

Exit Strategies

The great thing about Subject-To is that you have any number of exit strategies: once you have the deed, you own that house. You can do anything you want with it to get rid of the original seller’s loan. You can lease option it to another investor if you like, but any way you can think of selling will work, if you do it right.

Here, presented in random order, are just of the many profitable exit strategies possible with Subject to:

Land contract

Hold onto the property for 1–2 years with a new buyer paying the mortgage, plus some extra, with a balloon at the end for the deed. You end

up with a downpayment, the monthly extra you decide on, and the balloon payment at the end.

Sell it conventionally

Sell by FSBO or with a realtor. Have the funds at closing pay off the original mortgage; the rest goes to you. (This assumes you paid less than retail for the home, which in this market you should easily be able to do.)

Rent it out

If you can make it cash flow, this is monthly money in your pocket (in this case the note stays in the original seller’s name longer).

Refinance

Get your own mortgage on the house, pay off original seller’s loan and do whatever you want to make payments on what is now your mortgage.

While Subject-To deals represent a great strategy in the current real estate market, they must be entered into realistically and with integrity. A lot of people mistakenly believe that Subject-To arrangements offer 100% gain with zero responsibility. To these cowboy types, Subject-To deals are like a magical apparition from the not-too-distant past: an obligation-free way to produce wealth out of thin air.

Doing It Right

There are several types of ethical and profitable Subject-To deal structures including:

1.  No money exchanged

2.  Buyer pays money up front

3.  Buyer pays money in the end

4.  Buyer pays money both up front and in the end

5.  Seller pays money to the buyer to take the deed.

Legally speaking, in a Subject-To deal, as the buyer, you are not legally responsible for the mortgage, should it foreclose. It remains in the seller’s name. But that doesn’t mean you are absolved of responsibility, or that you don’t need to invest any of your own money.

The contract you sign to take on the seller’s mortgage payments is enforceable in court, which means you need to hold up your end of the bargain. If the mortgage is in pre-foreclosure, you need to get the mortgage current before you can take it Subject-To. And if you want to sell the property, you’ll need to foot the bill for any repairs or retrofits you want to make prior to the sale. Which is all reasonable enough.

So what about the banks?

Many investors steer clear of Subject-To deals because of a fear that the bank involved may invoke what’s called a “due on sale” clause in the contract and call in the mortgage. A due on sale clause states, in legalese, that the bank has the right to call the mortgage in if they can establish that there has been a transfer of interest in the property.

But banks are not in the business of calling in mortgages, and suffering the consequent foreclosure costs, if the asset is performing. As has been amply demonstrated in recent times, banks are in the business of making money. If they decide to call the mortgage in, not only do they not receive any further payments, but they cannot lend against its value. Which is why banks seldom, if ever, actually act on this clause.

Entered into with integrity, Subject-To deals represent a sound and profitable way to invest in real estate in the current market. If you’re looking to get into the real estate market, but don’t know where to begin, a Subject-To deal can be a great place to start.

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