Buying Subject to an Existing Loan
Subject to Sales Are Not Loan Assumptions
When interest rates rise, "buying subject to" suddenly starts to look like a very attractive financing option for home buyers. When interest rates are low, homebuyers tend to avoid subject to transactions. But interest rates aren't the only factor used to determine whether a buyer might make a purchase offer with a subject to financing.
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 taking over the payments. The unpaid balance of the existing mortgage is then calculated as part of the buyer's purchase price.
If a buyer doesn't make their payments, they could lose their home along with any possible equity. However, there is no personal liability beyond the loss of their home.
Reasons a Buyer May Purchase a Home Subject to a Mortgage
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 a loan is they may not qualify for a traditional loan with favorable interest rates. When considering a subject to sale with a prospective buyer, the seller should pull the buyer's credit report to determine the buyer's creditworthiness. Even if the buyer has a low credit score, the seller may still opt to continue with the sale.
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 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 in the event of alienation.
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 purchase money loan. 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 allow for a loan assumption but most conventional loans do not.
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.