September 30, 2024 | 3.5 Minute Read
Last week, a real estate agent reached out to discuss the sale of one of her listings. She received two “Subject To” offers and wanted to gain a better understanding of whether these offers should be considered. To review, a “Subject To” strategy in real estate involves taking over the seller’s existing mortgage payments without formally assuming the loan. The mortgage stays in the seller’s name, but the buyer gains ownership when the seller deeds over the property. The buyer continues to make the monthly payments.
Advantages:
You avoid qualifying for a new loan, which can be beneficial if you want to reduce up front capital and transaction costs associated with new loans (e.g., closing costs, lender fees, appraisals).
Since you’re not taking out a new mortgage, the only upfront costs are the seller’s equity, possible back payments, and closing costs. This can be much less than a typical down payment on a new mortgage plus closing costs using a hard money or a conventional loan with 20% down.
If the existing loan terms are favorable (low interest rate, fixed payments), you could rent and cash flow the property, especially in markets where mortgage rates are rising.
You can structure the deal creatively, offering different ways to compensate the seller, such as paying off their equity over time or upon resale. This is especially favorable if your equity in the property increases over time. You sell the property, pay off the existing mortgage and hopefully make a decent profit minus any upfront costs. However, if values decrease it may take some time before prices rebound causing you to hold on to the property longer than you may want.
Disadvantages:
Most mortgages include a due-on-sale clause, which gives the lender the right to demand full payment when the property is transferred. Though rarely will a lender call a note due as a result of the deed being transferred but it is still a risk, albeit small.
Since the loan remains in the seller’s name, missed or late payments could damage their credit. If this happens, it could lead to legal disputes and credit damage.
If the seller is already behind on payments or has liens on the property, you may have to bring the loan current or resolve other debt issues to avoid foreclosure.
While it’s possible for a seller in a “Subject To” deal to obtain a loan for another property, they must be prepared to demonstrate that they are not financially burdened by the existing mortgage. Some lenders are more accommodating and understand “Subject To” arrangements. Others may be stricter, requiring the existing mortgage to be paid off or demanding more extensive documentation to ensure the former “deed owner” is not financially overextended.
So now that we understand both the benefits and disadvantages of a Subject To strategy, let’s briefly look at the two offers the agent asked me to review with a property holding a $238,950 mortgage balance.
First Offer:
$238,950 – Offer
$0.00 – Cash at closing
Closing costs – Paid by buyer
10-day inspection period
$1,000 deposit at time of acceptance
Close October 16
“In the event that Buyer defaults on the mortgage payments and the mortgage goes into default, Buyer agrees to transfer the deed back to the Seller as a deed in lieu of foreclosure. This deed transfer will serve as an alternative to formal foreclosure proceedings, and Seller will regain full ownership of the property. Buyer further agrees to cooperate fully in executing any documents necessary to effectuate this transfer.”
The offer doesn’t involve any upfront cash (the $1,000 deposit is a credit towards the purchase price), so there’s no real commitment from this buyer and zero incentive for the seller to consider this offer, unless they are desperate to sell.
Second Offer:
$256,590 – Offer
$18,000 – Cash at closing
Closing costs – Paid by buyer
10-day inspection period
$2,000 deposit on or before end of inspection
Close October 15
“If Buyer is more than 30 days late on any mortgage payment the property is transferred back to original seller within 14 days” & “Buyer reserves the right novate this agreement with a replacement agreement with a third-party purchaser.”
This offer includes $18,000 in cash, making it more appealing. And, this buyer has the right to novate the property, giving the buyer two potential options (more on novation in a future article). I suspect this buyer is dangling $18,000 cash at closing. More than likely, they will eventually novate the contract and find another buyer who has the cash to close.
Neither buyer faces consequences if they stop making mortgage payments. Although the wording may seem to favor the seller, it does not. In reality, missed payments damage the seller’s credit, and any outstanding arrears will need to be paid, adding to the seller’s financial strain. Wasn’t the whole point of a “Subject To” contract to help the seller avoid financial hardship?
A Subject To contract is a powerful strategy to use, but its effectiveness increases significantly when you are face-to-face with the seller and have a clear grasp of their needs, challenges and pain points. This understanding allows you to determine the right moment to introduce this strategy into your conversation. Your chances of success are much higher then simply submitting a Subject To blind offer to an agent.