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Ultimate No Money No Credit Strategy Subject To...

By: Tom Bukacek
Submitted: 09:28PM on Friday 24 April 2009

Regardless of your experience level or finances, the best type of real estate investment is the type where you invest as little of your own capital and risk as little of your own credit as possible. One of the best strategies out there that meets these criterions is known as 'subject to'.

Every purchase agreement has a subject to clause. A ‘subject to’ offer simply means that the buyer is willing to purchase a piece of property ‘subject to’ some specific circumstance. Usually that circumstance will be subject to an inspection, or subject to new mortgage or something of the like.

But for the sake of this article, the use of the term ‘subject to’ is in relation to purchasing a property "subject to the sellers existing mortgage remaining in place.” This phrase means that at closing, the property is titled in the buyer’s name, but the loan is still in the seller’s name. Therefore, you are buying the property ‘subject to’ the sellers existing mortgage payments.

This statement means that you are not assuming the loan. The terms you create with the seller are between the two of you as long as you follow to the letter the terms set up when the loan was conceived.

Why on Earth would someone just give you the deed to his or her home? Many motivated sellers are willing to trade EQUITY for Peace of Mind. If someone is finically strapped and doesn’t want a foreclosure on their record, or their job is being relocated and they don’t wish to be landlords from afar, or they are going through some other personal hardship, they may be willing to sell their home as quickly as possible in whatever way possible and as low a price as possible in exchange for the relief of not being responsible for the debt any longer.

For example, I recently purchased a property ‘subject to’ from a gentleman in Pflugerville, TX, for $126,000. The property value was $145,000. The house was less than 2 years old and was in immaculate condition. Why did he sell to me subject to? Because his job was transferring him immediately to Georgia. He did not feel comfortable being a landlord from afar. He also felt (accurately) that to sell his house quickly, he’d have to drop the price. After closing costs and fees, he’d probably be upside down. This method of selling his house to me ‘subject to’ the existing financing remaining in place achieved his goals of ridding himself of the property quickly without coming out of pocket.

Purchasing their house ‘subject to’ can provide the motivated seller with instant debt relief and help them out of their situation immediately.

Once you acquire the property in such a manner, what exit strategy should you use? The best strategy in this situation is to find a buyer and finance the transaction. You, as the investor, now become the BANK, and like a bank, you create multiple money making opportunities for your business.
How does owner financing work? Suppose you come across a family that has cash, a FICO score in the mid 600’s, and has been at their place of employment for 1 year. Can this family get conventional financing in this current market? No. Would YOU be willing to seller finance this property? Yes. So with this strategy, you can help a family who cannot purchase a home using traditional methods. Plus, your owner financing fee that you will charge them will be less than typical closing costs.

How do you as the owner of the property make money when owner financing? There are four ways:
1- Make money with the owner financing fee. Typically, as the owner, you can charge between 4-7%. This fee is non-refundable.
2- Make money with the monthly spread. When you take over a mortgage with a 5.25% interest rate, you are not going to charge a 5.25% interest rate to you new buyer. Rather, you will probably mark up the rate to 8-12%. On average, you will want to make a minimum monthly profit of $200.
3- Make money when you sell the property. If you purchased ‘subject to’ and the loan amount was $120,000 and then you sold for $150,000, when the buyer refinances the mortgage with another bank 2-3 years later, you will profit the difference.
4- Tax benefits such as depreciation and interest deductions.

So as you can see, purchasing subject to is a ‘Win-Win-Win’ for all parties involved. It is a ‘Win’ for the motivated seller because they have peace of mind. It is a ‘Win’ for the buyer because they can now move into their dream house. And this strategy is a ‘Win’ for the investor because they add a profitable transaction to their portfolio without using their own money or credit!

With Subject to, are you assuming the loan? NO. When a property owner sells his home ‘subject to’ the existing mortgage, the buyer must make the payments on the mortgage or get foreclosed on, like a traditional mortgage. However, since the buyer is not legally obligated to the bank to make payments, the foreclosure will not have a negative impact on the buyer's credit where it will have an impact on the seller’s credit.

Does this mean that the buyer has no pressure to make payments? Absolutely, unequivocally wrong! First off, if you purchase the property and sell it correctly, and manage each property as its own business entity, then you will never have any reason to miss a payment. But even more than the business reason, the investor has a moral obligation to both the seller he purchased from as well as the buyer to whom the property was sold to make those payments. Your word is the most important thing you have. Keep it.

Finally, the most common question asked by the investors is "What about the due on sale clause?" This one concern often times keeps numerous investors from purchasing properties using the ‘subject to’ method. So what does that due on sale clause actually say?

Typical due-on-sale language states that, “the Lender may, at its option, declare immediately due and payable all sums secured by the Mortgage upon the sale or transfer, without the Lender’s prior written consent, of all or any part of the Real Property, or any interest in the Real Property.”

First and foremost, people say that due to this clause, performing a ‘subject to’ is illegal. The due on sale clause is a clause in a contract. This is not a government statute! If the lender chooses to execute this clause, you will not go to jail. There is nothing illegal about purchasing a property ‘subject to’.
Second, the word that stands out is the word may. For a rule to be absolute, the language must be definitive. The due on sale using the word ‘may’ means that this rule is subjective and not absolute.

A reading of the language shows that the term, ‘due-on-sale’ is misleading. In fact, the mortgage may be called in if there is any transfer of any interest in the real estate, and not just a sale of the property.

For example, it is possible that even a long term Lease will allow the Lender to accelerate their mortgage, especially if the Lease contains an option to purchase. But any Lease that contains an option to purchase will be sufficient to call in the loan if it contains an option to purchase the property, regardless of the length of the Lease. Have you ever heard of a lender calling a note due because the owner was renting or leasing the property? Of course not. The same scenario holds true for purchasing properties ‘subject to’.

In reality, very few due on sales clauses are ever called in. Between my own deals and those of the people with whom I work, I have not heard of any instance out of over 600 transactions where the due on sale clause was invoked.
Why? Understand that the job of a lender is to collect payments. They loan out money at a higher interest rate then they are paying and create their cash flow from the difference on that spread. Why stop this profitable process?

Banks are not motivated to ever take a performing asset and turn it into a non performing asset. When an asset is performing, they are allowed to lend 9 times its value and collect interest on that amount. When the asset is not performing, they cannot loan out eight times the amount loaned.
Example. Let’s say you purchase a property ‘subject to’ the existing finance staying in place. The loan amount is $200,000. As long as the asset is performing, the bank can loan and collect interest on $1,800,000. Now, if they decide to execute the due on sales clause, then the bank would not only stop receiving money on that loan, but they would put it into the ‘bad debt’ category and not be able to loan out $1,600,000 until the bad debt is resolved.

As you can see, there is little motivation for the bank to ever evoke the due on sales clause.

In conclusion, purchasing homes ‘subject to’ is a creative, quick, low risk, and financially rewarding way to add to your real estate investing portfolio. Under current Fannie Mae guidelines, an individual may own up to 10 homes before being considered overleveraged. With this strategy, you may own as many homes as you can buy. I know and work with a gentleman in Austin, TX, who currently owns more that 90 properties, each cash flowing over $300/month. Would this passive cash flow change your life?

The ‘subject to’ method of buying homes allows the investor to achieve financial freedom with little risk and great rewards. It takes little money to get started buying homes 'Subject To' and, is quicker and easier to sell a home when the banks are not involved.