Buying Subject to an Existing Loan
Subject-to Sales Are Not Loan Assumptions
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.
What Buying Subject to Means
Buying subject to means buying a home subject to the existing mortgage. It means the seller is not paying off the existing mortgage, and the buyer is instead taking over the payments. The unpaid balance of the existing mortgage is then calculated as part of the buyer's purchase price.
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, and the buyer has no legal obligation to make the payments. Should the buyer fail to repay the loan, they could lose their home to foreclosure, but 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, and for real estate investors who plan to rent or re-sell the property down the line, that means more room for profits.
For a general homebuyer, the primary reason for buying subject-to is to take over the seller's existing interest rate. If present interest rates are at 7% and a seller has a 5% 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 5% interest rate is amortized at a payment of $1,073.64 per month
- A $200,000 mortgage at a 7% interest rate is amortized at a payment of $1,330.60 per month
- The monthly savings to a buyer under these circumstances is $256.96 or $3,083.52 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.
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
A subject-to sale does not necessarily involve owner financing but it could. Whether the seller carries any type of financing depends on whether they wrap the mortgage or the amount of the down payment versus the purchase price.
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 in cash.
- 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, if the sales price is $200,000, the existing loan balance is $150,000 and 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. For example, an existing mortgage carries an interest rate of 5%. If the sales price is $200,000 and the buyer puts down $20,000, the seller's carryback would be $180,000. At a rate of 6%, the seller makes 1% on the existing mortgage of $150,000 and 6% on the balance of $30,000. The buyer would pay 6% on $180,000.
The Difference Between a Subject-to and a Loan Assumption
In a subject-to transaction, neither the seller nor the buyer tells the existing lender that the seller has sold the property and the buyer is now making the payments. The buyer did not obtain the bank's permission to take over the loan. 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. This simply means the loan balance is due in full.
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 can't pay off the loan upon the bank's demand, the bank could initiate foreclosure.
If a buyer does a loan assumption, the buyer formally assumes the loan with the bank's permission. This 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, but the fee is much less than the fees to obtain a conventional loan. FHA loans and VA loans allow for a loan assumption but 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 resell 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.
What We Like
Fewer up-front costs
Easier to qualify
May equal more profits for investors
May equal more favorable interest rates
What We Don't Like
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 both buyers and sellers. Before entering into this type of agreement, you should understand the various options along with their benefits and drawbacks.
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Carleton Sheets. "What You Need to Know About Subject-to Transactions." Accessed Dec. 10, 2019.
Than Merrill. "Everything You Should Know About a Subject To Mortgage." Accessed Dec. 10, 2019.
FDIC. "8000 - Miscellaneous Statutes and Regulations." Accessed Dec. 10, 2019.
Penny Mac. "Understanding Assumable Mortgages." Accessed Dec. 10, 2019.
U.S. Department of Veterans Affairs. "Rights of VA Loan Borrowers." Accessed Dec. 10, 2019.
U.S. Department of Housing and Urban Development. "Chapter 7: Assumptions." Accessed Dec. 10, 2019.
National Real Estate Insurance Group. "How to Insure Your “Subject to” Property." Accessed Dec. 10, 2019.