About ‘Subject To’ Contracts
All real estate transaction have a Subject To clause. In a traditional home purchase agreement, the deal is subject to home inspection, the buyer qualifying for and obtaining a mortgage and home appraising at or above the agreed to purchase price.
What Is It?
A Subject To Agreement basically means that the buyer is subject to the existing mortgage. This means that the buyer is willing to take over your current mortgage payments. When negotiating the purchase price, the existing mortgage is calculated as part of the buyer’s final purchase price.
Subject To Agreements were widely used following the 2006/07 market crash. Many families, having lost their retirement savings and their jobs were struggling to sell their home. Many chose to walk away from the property and let the banks foreclose on it, thereby, destroying their credit in the process for years to come.
However, another alternative that did, in fact, help those sellers who employed it, was to enter into a Subject To Agreement. Here the buyer puts down a small downpayment, pays a transaction fee and then assumes the existing mortgage payments on behalf of the seller.
Who Would Benefit?
Subject To Agreements are designed and written to benefit both buyer and seller. It is a mutual agreement crafted between both parties that clearly outline agreed to purchase price, dates, seller financing terms, etc. They are completely legal and happen more often than you would think.
So who would utilize this type of deal?
- People who own distressed property.
- Investors selling investment property.
- Investors purchasing distressed or income property.
- Family members who inherited distressed property they don’t want to have to put money into to in order to get it market ready.
- Folks who find themselves in tough financial situations, are struggling to make payments on their mortgage and don’t think they can sell on time before it goes to foreclosure.
What Makes A Subject To Agreement Attractive?
There are several reasons this type of arrangement is attractive to a home buyer. They are:
- The buyer has difficulty obtaining lender financing.
- Current rising interest rates are making it difficult to finance a purchase.
The latter is often the main reason for buying Subject To. As current interest rates rise, more and more buyers will be pushed out of the market, unable to afford the monthly payments.
However, by assuming an existing mortgage rate at a much lower interest rate will make a big difference in their affordability.
A Win/Win Scenario
So why would a seller be willing to enter into such an agreement? Why not just sell the house? Why in the world would they give up equity or title? Why risk their credit?
Unfortunately, sometimes bad things just happen even to the best of folks. People can get themselves into challenging situations that leave them with tough decisions.
Win #1 – Seller
Sellers of a distressed property, for instance, can simply walk away from. They don’t have to clean it out or fix anything. There was no home inspection, certificate of occupancy or termite report.
Rather than letting it go to foreclosure, a seller’s credit is preserved because foreclosure is averted. Banks don’t care who is paying your mortgage, so long as someone pays it on time every time. For every payment that the buyer makes on the sellers behalf, continues to build seller’s credit. Typically, both the buyer and the seller have online access to keep track of the loan payments.
Seller also resolves all holding costs. The related expenses associated with the property, it’s taxes, maintenance, utilities and repairs are also assumed by the buyer. Seller has no holding costs.
If the existing mortgage payment is low enough, seller could tack on a little extra profit monthly. Thereby turning a deficit into income property.
Also, seller receives the buyer’s downpayment sum. The downpayment is agreed upon by both sides and typically runs from 3% to as much as 20% of market value.
As good as it sounds, there is some risk involved here. Technically, because the mortgage is still in the Seller’s name, he/she is still financially tied to the property on paper.
However, for those who are unable to sell a property but need to eliminate the expenses related to holding the property, entering into a Subject To Agreement could be a viable solution.
Win #2 – Buyer
There are plenty of buyers out there with good incomes but struggle to qualify for a mortgage.
This is often the case with entrepreneuers and contractors. Banks today, are looking for people who can show a consistent 1099 and a paycheck.
I’ve seen many banks turn away entrepreneurs and subcontractors simply because they don’t fall into this category although they have good income.
A Subject To Agreement gives the buyer a way to secure a property by assuming the sellers current mortgage payments at a locked in rate, utilities, and taxes.
Buyer gets all the tax advantages and low closing costs since there are no lender points, lender fees or appraisals added on. Typically, these are quick closings but title insurance will still be required.
For the price of a downpayment, they secure the property and possess it as their own. There’s no need to qualify for a loan and the buyer has no personal liability on the debt. it’s a great way to obtain long-term financing without ever going through a bank.
3 Types of Subject To Options
This is the most common form of subject to agreements. When the buyer pays in cash the purchase price and the existing loan balance.
For instance, if the sellers existing mortgage loan balance is $200,000 and the sales price is $250,000, the buyer pays the to the seller the $50,000 difference.
Seller financing can be in the form of a second mortgage to the buyer, land contract or a lease option.
If the sales price is $250,000 and the existing mortgage balance is $200,000 and the buyer down payment is $20,000, then the seller would finance the remaining $30,000 balance in the form of a loan to the buyer. Separate interest rate and terms for the $30,000 loan would be negotiated. The buyer agrees to make one payment to the existing mortgage lender and a separate payment to the seller.
In this case, the seller also charges a small interest on the existing loan to the buyer. Let’s continue to use the same numbers. Purchase price is $250,000 and existing loan balance is $200,000 at a rate of 4%.
The buyer’s downpayment is $20,000 and you charge them 5% on the remaining $30,000 loan. However, in a Wrap Around Agreement, you also can charge 1% interest on top of the existing mortgage rate, giving you a little extra on the side. Giving you 1% on the $200,000 mortgage in addition to the 5% on the seller financed loan of $30,000.
Subject To vs Loan Assumption
The main difference here is that with a Subject To Agreement, neither the buyer nor the seller inform the lender that the property has been sold and that the buyer is now making the payments. In other words, the buyer did not obtain the bank’s permission to take over the loan. Typically, banks don’t really care who is making the payments just as long as the payments are made in full and on time.
However, lenders do have some legal verbage in their mortgage Promise to Pay and in the trust deeds that can give the lender the right to call the loan and force full payment. Rarely do banks actually call the loan in these circumstances but it still poses some risk to the buyer if he/she is unable to comply.
In a loan assumption, the buyer gets the banks permission to assume the loan formally. This means the seller’s name is removed from the loan and the buyer has to qualify for the existing loan.
What’s The Catch?
I already touched on a couple of risks but lets go over some additional things to keep in mind.
Property Liens – Make sure to use a title agency or a real estate attorney in this transaction. You’ll want to make sure there are no outstanding liens on the property. Obtaining title insurance will help cover you.
Due On Sale Clause
Remember I mentioned the lenders financial lingo earlier? Well, it’s referred to as a Due On Sale Clause and what it typically says is that the lender has the right to call the loan if the title changes hands.
I did some research and rarely do banks call a loan. I did find an instance where the bank called the loan because they knew that the original borrower was deceased.
Another situation where an investor took over a home Subject To and turned it into an income property. Sometime later, the mortgage company sold the loan to a third party who then called the loan when they noticed it had transferred hands and there was equity in the property. In this case, the investor simply refinanced the property and paid the lender off. Click for more on this.
Who Holds The Policy?
In order to avoid tipping off the mortgage lender, it’s best if the seller continues to insure the property until the buyout is completed.
Having two policies on the property (one in sellers name and the other in buyers name) is not a very good idea. You could end up in a situation where both insurance companies will deny a claim down the road.
It’s probably easier to have both parties named as insured or additional insured on the same policy, including previous and current owners.
Questions or Comments
So what do you think? Did I give you something to think about here? Let me know if you have any questions at all.