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What is “subject to”? What are the pros and cons for real estate investing?

In the world of real estate investing, investors have many tools at their disposal. “Subject to” is one approach some investors use successfully in their business.

This article will cover what it means to do a subject to deal, and the pros and cons for real estate investing. We’ll also discuss the types of subject to deals and the difference between subject to and assuming a loan.

Have questions? We’re here to answer them! Whether you’re already a real estate investor in the Des Moines area or are just thinking about investing, we’re here to help. Don’t hesitate to contact us!

What is  “subject to” in real estate?

Subject to, also called subject 2 or sub2, is when a property is purchased “subject to” a seller’s existing mortgage loan. Essentially, a buyer takes over a seller’s mortgage payments on a property without an official agreement with the existing mortgage lender.

In other words, the current mortgage on the property remains in the seller’s name, and the deed gets signed over to the buyer. 

Legal implications of subject to deals

Each state has different laws relating to subject to transactions. We recommend you research your local laws and consult your attorney before entering into any subject to contract.

What’s the difference between “subject to” and assuming a mortgage?

With subject to, the buyer takes over the seller’s existing mortgage – without involving the lender. The buyer (and seller) don’t inform the lender of their agreement, nor do they get the lender’s consent when the buyer takes over the mortgage payments.

On the other hand, when a buyer assumes a seller’s mortgage, the buyer becomes the official mortgagee. The buyer gets loan approval and signs an agreement with the lender for repayment. The seller’s name is then taken off of the original mortgage, leaving them with no further obligation to the lender.

The buyer generally pays more closing costs when assuming a mortgage. Still, it’s a safer bet, and often more economical than securing a new loan. Both the buyer and the seller take on more risk in subject to agreements (read on).

Some types of mortgage loans allow buyers to assume their mortgages, while others don’t. FHA and VA loans are two types of loans that permit assumption. But most conventional loans do not. 

Why would a seller want to do a subject to deal?

Sellers experiencing financial hardships often seek immediate relief by selling subject to. Money problems, like losing a job, getting divorced, or racking up medical debt, are a few reasons sellers consider a subject to sale. 

It gives them a quick solution to their financial issues with the potential to improve their credit. As long as the buyer follows through by making the payments and eventually paying off the loan, it can work. But it’s not without risk.

Subject to deals can put sellers in a risky financial position. Suppose the buyer stops making the loan payments. In that case, the seller will pay the consequences because they’re still legally responsible for the loan. Missed payments negatively impact the seller’s credit and could result in foreclosure. A subject to deal gone awry can take sellers years to recover.

What are the pros and cons of subject to real estate deals?

As a real estate investor, subject to deals offer a low-cost way to invest, especially for new investors. And whether you’re reselling or renting the property, lower costs create a wider profit margin.

But don’t be too quick to jump on the subject to bandwagon. These deals carry risks to buyers and sellers alike.

Pros

  • Less costly. There are no loan origination fees, appraisals, or other closing costs in a subject to transactions. And the interest rate on the existing loan is often lower than getting a new loan on the property. 
  • No loan qualification. Buying subject to is a way for buyers to use traditional financing without ever qualifying for a loan.
  • It’s quick to close. With no lender involvement, it is faster to close subject to deals.

Cons

  • Due on sale clause. Written into every bank’s mortgage agreement is a “due on” clause. It allows the lender to exercise their right to accelerate the loan and call it due if ownership gets transferred. That’s not to say that lenders will actually use the clause. Some banks don’t call the loan, even when they find out ownership has changed. But they can. If a lender exercises this right, the loan has to be paid in full – or it goes into foreclosure.
  • Possible seller bankruptcy. If the seller has significant financial issues and ends up in bankruptcy, the property could get seized.
  • Insurance can be tricky. Since the buyer officially owns the deed to the property, the buyer should also carry the insurance. But because the seller is still on the mortgage, they usually need to be on the policy too.
  • Existing liens on the property. A thorough title search hedges this risk.

Types of subject to deals (how they’re structured)

In a subject to transaction, the buyer and seller sign a contract stating the agreement’s terms. There are three types of subject to transactions.

Straight subject to cash-to-loan

A straight subject to cash-to-loan is the simplest and most common way to structure a subject to deal. Here, the buyer pays the seller the difference between the purchase price and the mortgage balance – in cash. 

For example, let’s say the seller has a mortgage balance of $100,000. The buyer offers the seller $150,000 for their property. If the seller agrees, the buyer pays the seller $50,000 in cash (and is also responsible for the $100,000 mortgage balance on the seller’s loan). 

Straight subject to with seller carryback

Subject to deals with seller carryback means the seller lends the buyer the difference between the purchase price and the mortgage loan balance. It’s essentially a second mortgage carried by the seller. 

For example, let’s say the seller has a mortgage balance of $100,000 and has agreed to a purchase price of $150,000 for their property. The buyer makes a cash down payment of $10,000 to the seller. The seller lends the buyer the difference of $40,000 with interest. The buyer would make one monthly payment to the seller (for the $40,000 seller financing portion) and a monthly payment to the lender (on the $100,000 mortgage loan).

Wrap around subject to

Wrap around subject to is seller financing for the entire purchase price. The seller typically charges a higher interest rate than their existing mortgage interest rate. In this case, the seller continues to make the payments on the existing mortgage, while collecting payments from the buyer for the sales price (minus any down payment). Here, the seller makes money on the mortgage loan balance by charging more interest.

For example, the buyer and seller agree to a purchase price of $150,000. The seller still owes $100,000 on the original mortgage at an interest rate of 4%. The buyer makes a $10,000 cash down payment. The buyer agrees to pay the seller an interest rate of 5% on the balance of $140,000. The seller makes an extra 1% on the $100,000 existing mortgage. 

Closing thoughts on subject to for investors

Subject to can work for both investors and sellers, but both sides carry risks. Investors should carefully consider the pros and the cons, and always keep the seller’s best interests as a priority when considering using subject to as an investing tool. 

2020-09-25T10:39:11-05:00

About the Author:

Amanda has lived in the Des Moines area since 1999, where she and her husband have bought and sold a handful of homes over the years, including a recent flip. Amanda enjoys writing, obsesses about personal finance and is fond of looking at houses. She loves sharing useful tips and info to make life easier for anyone wanting to buy or sell a home. In her spare time, Amanda cherishes time with her family, volunteers with IHYC, gardens, hikes, and practices TaeKwonDo. You can read more of her writing at whywemoney.com