How Subject-To Loans Work in Real Estate

Couple signing paperwork to buy a house
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Buying a property "subject-to" means a buyer essentially takes over the seller’s remaining mortgage balance without making it official with the lender. It’s a popular strategy among real estate investors. When interest rates rise, it may also be an attractive financing option for general homebuyers.

Learn more about buying subject-to, how it works, and the pros and cons of this strategy.

Key Takeaways

  • Buying subject-to means the homebuyer is taking over the mortgage payments with no official agreement in place with the lender. 
  • Buying a subject-to home is attractive to buyers if they can get a lower interest rate by taking over payments. 
  • This arrangement poses risks for the buyer if the lender requires a full loan payoff or if the seller goes into bankruptcy.

What Does Buying ‘Subject-To’ Mean in Real Estate?

Buying subject-to means buying a home subject-to the existing mortgage. It means the seller is not paying off the existing mortgage. Instead, the buyer is taking over the payments. The unpaid balance of the existing mortgage is then calculated as part of the buyer's purchase price.

For example, let's say the seller took out a mortgage for $200,000. They had paid $150,000 of it before they decided to sell the home. The new buyers would then make payments on the remaining $50,000.

Under a subject-to agreement, the buyer continues making payments to the seller’s mortgage company. However, there’s no official agreement in place with the lender. The buyer has no legal obligation to make the payments. Should the buyer fail to repay the loan, the home could be lost to foreclosure. However, it would be in the original mortgagee’s name (i.e., the seller).

Reasons a Buyer May Purchase a Subject-To Property

The biggest perk of buying subject-to real estate is that it reduces the costs to buy the home. There are no closing costs, origination fees, broker commissions, or other costs. For the real estate investor who plans to rent or re-sell the property down the line, that means more room for profits.

For most homebuyers, the primary reason for buying subject-to properties is to take over the seller's existing interest rate. If present interest rates are at 4% and a seller has a 2% fixed interest rate, that 2% variance can make a huge difference in the buyer's monthly payment. For example:

  • A $200,000 mortgage at a 2% interest rate is amortized at a payment of $739.24 per month
  • A $200,000 mortgage at a 4% interest rate is amortized at a payment of $954.83 per month
  • The monthly savings to a buyer under these circumstances is $215.59 or $2,587.08 per year

Another reason certain buyers are interested in purchasing a home subject-to is they may not qualify for a traditional loan with favorable interest rates. Taking over the existing mortgage loan may offer better terms and fewer interest costs over time.

Note

Buying subject-to homes is a smart way for real estate investors to get deals. Often, investors will use county records to locate borrowers who are currently in foreclosure. Making them a low, subject-to offer can help them avoid foreclosure (and its impact on their credit) and result in a high-profit property for the investor.

Three Types of Subject-To Options

Not all subject-to loans look the same. Typically, there are three types of subject-to options.

A Straight Subject-To, Cash-To-Loan

The most common type of subject-to is when a buyer pays in cash the difference between the purchase price and the seller's existing loan balance. For example, if the seller's existing loan balance is $150,000 and the sales price is $200,000, the buyer must give the seller $50,000.

A Straight Subject-To With Seller Carryback

Seller carrybacks, also known as seller or owner financing, are most commonly found in the form of a second mortgage. A seller carryback could also be a land contract or a lease option sale instrument.

For example, let's say the home's sales price is $200,000, with an existing loan balance of $150,000. The buyer is making a down payment of $20,000. The seller would carry the remaining balance of $30,000 at a separate interest rate and terms negotiated between the parties. The buyer would agree to make one payment to the seller's lender and a separate payment at a different interest rate to the seller.

Wrap-Around Subject-To

A wrap-around subject-to gives the seller an override of interest because the seller makes money on the existing mortgage balance. A wrap-around is another loan that contains the first and it can be seller-financed.

Using the example above, let's say the existing mortgage carries an interest rate of 2%. If the sales price is $200,000 and the buyer puts down $20,000, the seller's carryback would be $180,000.

By charging the buyer 3%, the seller makes 1% on the existing mortgage of $150,000 and 3% on the balance of $30,000. The buyer would pay 3% on $180,000.

Subject-To vs. Loan Assumption

In a subject-to transaction, neither the seller nor the buyer tells the existing lender that the seller has sold the property. The buyer is now making the payments. The buyer did not obtain the bank's permission to take over the loan.

Warning

Lenders put special verbiage into their mortgages and trust deeds that give the lender the right to accelerate the loan and invoke a “due-on” clause in the event of a transfer. It means the loan balance is due in full, and this could put the new homeowner at risk of losing the home if the lender finds out about the transfer.

Not every bank will call a loan due and payable upon transfer. In certain situations, some banks are simply happy that somebody—anybody—is making the payments.

But banks can exercise their right to call a loan due to the acceleration clause in the mortgage or trust deed, which is a risk for the buyer. If the buyer doesn't have the cash in hand to pay off the loan upon the bank's demand, it could initiate foreclosure.

Loan assumption, on the other hand, is different than a subject-to transaction. If a buyer makes a loan assumption, the buyer formally assumes the loan with the bank's permission. This method means the seller's name is removed from the loan, and the buyer qualifies for the loan, just like any other kind of financing.

Generally, banks charge the buyer an assumption fee to process a loan assumption. The fee is much less than the fees to obtain a conventional loan. FHA loans and VA loans allow for a loan assumption. However, most conventional loans do not.

Pros and Cons of Buying Subject-To Real Estate

Subject-to properties mean a faster, easier home purchase, no costly or hard-to-qualify-for mortgage loans, and potentially more profits if you're looking to flip or re-sell the home.

On the downside, subject-to homes do put buyers at risk. Since the property is still legally the seller's liability, it could be seized should they enter bankruptcy. Additionally, the lender could require full payoff if it notices the home has transferred hands. There can also be complications with home insurance policies.

Pros
  • Fewer up-front costs

  • Faster sale

  • Easier to qualify

  • May equal more profits for investors

  • May equal more favorable interest rates

Cons
  • Home could be seized if seller goes into bankruptcy

  • Lender could accelerate the loan and require full payoff

  • Insuring the home could be complicated

The Bottom Line

While a subject-to sale may seem desirable for some, it comes with risks for buyers and sellers. Before entering into this type of agreement, you should understand the various options along with their benefits and drawbacks.