"Subject to" Misinformation

Greetings BP Community!!

I’ve gotten so much out of just the couple of months I’ve been on BP that I thought I would try to actually add some value. (We’ll see how that goes!)

This past Saturday I attended my first meeting of one of the local DFW area REIA’s. It was a great experience, and I made some amazing contacts, so I would encourage all you newbies to get connected with a local REIA. However, I was sorely disappointed in the information and "training" being provided. The topic was "Subject to" investing, and I was amazed at how much misinformation there is from "expert" investors. I’m a REI newbie, so I’m definitely not an expert on anything related to REI, certainly not finding and exploiting deals using "Subject to" financing. However, I’ve spent 20+ years working for the biggest of the big banks. Here are a few of the areas of misinformation I encountered at the meeting. (Final Disclosure: I am NOT an attorney. This is not legal advice or a legal opinion. Please consult a licensed attorney, prior to taking any action.)

1. The "Due on Sale" clause is just that, a clause. Its purpose is to protect the lender. Mortgages are NOT assumable loans. There is a great deal of vetting and qualification that goes into getting someone approved for a mortgage. The lender has not had the opportunity to qualify some random person the original borrower may decide to allow to "take over payments" on their mortgage. (Also, you’re not "assuming" or "taking over the payments". You’re going to be wrapping another mortgage, with a lower position, around the existing mortgage.) The "Due on Sale" clause provides the mortgage originator with an escape that doesn’t require a full foreclosure action. The clause allows them to simply call the note due in full.

 Now, please understand the key idea is that it allows the lender to call the note due in full. It doesn’t require them to. Banks are not in the business of owning property, and they own billions of dollars of it already. They aren’t good at it, and that isn’t their business model. No bank, particularly with interest rates as low as they are (Google the history of Garn-St. Germain for an in-depth look at what was happening in the 80’s, when rates were in the mid- to upper-teens.) wants to turn a performing asset into a non-performing one. Therefore, as long as a mortgage remains current, there is no reason for the lender to act on the "Due on Sale" clause. Particularly with the larger (higher volume) originators, stay off of their radar, and it is unlikely they will ever take a second look at the original mortgage. (That means…stay current with the payments and taxes, if the taxes were not included as part of the original escrow, and make certain you maintain insurance. Those are the things that will get you the kind of attention you don’t want.)

2. Living Trusts (Inter Vivos) DO NOT protect you from the "Due on Sale" clause being triggered. Garn-St Germain clearly says that the "Due on Sale" clause is in play, unless the original borrower maintains a beneficial interest in the property and doesn’t give up the right to occupancy. (For those of you who are interested, here’s a link to the section of the act applicable to Due on Sale. http://www.law.cornell.edu/uscode/text/12/1701j-3) Therefore, unless you intend to allow the seller to maintain a partial interest in the property and maintain the right to occupy the property, the "Due on Sale" clause is still activated by the transfer into a Living Trust as part of a "Subject To" transaction. What the use of a Trust will do for you is help obfuscate the transfer. What do I mean by that?

Well, John & Jane Smith, as the original borrowers, own the property, and they create and then deed the property into the Smith Family Trust, which shows your company as the beneficiary. The new Deed of Trust with the owner listed as Smith Family Trust is unlikely to trigger any kind of investigation, simply because it will look like estate planning. There are other ways to structure the use of trusts to further obfuscate the sell and transfer of the property, but it’s just a shell game. All it does is help to hide the fact the property has been sold. It does NOTHING to actually protect you from the "Due on Sale" clause. In my personal (again…not a lawyer!) opinion, it is going to do nothing more than make your seller more nervous. It may be a somewhat beneficial strategy, if the original mortgage is held by a smaller or lower volume lender who may actually have someone with a clue looking at and filing collateral, but I don’t think it’s worth the effort dealing with the larger originators. They get hundreds of pieces of collateral a day. They have clerks slapping bar codes on them, scanning the receipt into their collateral system and throwing the documents into vaults.

3. Finally, there are a lot of benefits to utilizing a professional mortgage loan originator (RMLO), when you go to sell the properties you have acquired using the "Subject to" strategy. Simply from the standpoint of having a professional service your loans, you may feel it’s worth it. However, you don’t necessarily have to use a licensed RMLO. (Again…not a lawyer! This is NOT a legal opinion.)  If you are originating 3 or fewer mortgages within a 12-month period, you are exempt from the RMLO requirement in the Dodd-Frank Act.  Although, you may have some state mandates around disclosures and other fiduciary duties.  If I do 3 or fewer owner financed deals within a 12-month period, I DO NOT have to be a licensed RMLO. The whole of the Dodd-Frank Act sets forth some very complicated requirements and does limit the ability to incorporate Balloon payments, limits on ARM, negative equity, etc.  (Find a great break down on Dodd-Frank’s impact to Seller Financing by the National Association of Realtors here... http://www.ksefocus.com/billdatabase/clientfiles/172/4/1720.pdf)  Because "Subject to" will likely be one of my primary exist strategies, I will likely leverage a RMLO.  The point being, you may be exempt, if you aren't doing much in the way of owner finance.

I know there have been a ton of people who have written and spoken on this subject, most if not all more eloquently and knowledgeable than me. However, it’s clearly not sinking in for everyone, so I thought I would give it a try myself. Personally, I’m looking forward to leveraging "Subject to" financing as a focused exit strategy in my REI pursuits, and I don’t plan to make the use of Living Trusts a routine part of my equation.

Looking forward to your feedback and comments,

Hattie