Step by Step Subject to Existing Loan
Wholesaler · Hampton Roads, VA · Member since 2013 · 31 posts · 11 votes
Hi everyone,
So I understand the basic concept of a subject to agreement, where the seller agrees to sign over note or deed to the buyer, and the buyer begins making payments to the existing mortgage in lieu of the seller. I have a seller that is willing to agree to such a sale, but this will be my FIRST deal, and I want to make sure I dot all my I's and cross all my T's on this one. If someone could offer me some step by step info so I don't miss anything that would be great. Iv'e heard from threads and videos that others use their company name. Does this mean the deed cannot be transferred to an individual alone? Its questions like these that are leaving me stumped.
The "grantee" on the deed can be you or your LLC, as you wish. Putting the property into an LLC may be desirable for asset protection.
Ownership is with the buyer. The owner gets the mortgage interest credit.
Get a Power Of Attorney from the seller giving you the right to deal with anything related to the property.
Various theories w.r.t. notifying the lender. Some claim if you notify the lender and they do nothing you're off the hook on due-on-sale. I don't buy it. Nothing is going to protect you from the due on sale clause. As long as interest rates are low and the loan is getting paid I doubt the lender will call the loan. If interest rates go up (I paid 9% on a 15 year owner financed loan on the first house I bought in 1987 and was VERY happy with that deal), rest assured these subject to loans will get called.
There is a lot of discussion here about subject to. Do a search on that term and you'll get a much more thorough discussion than I will give.
I think this may make sense if you have a plan to pay off the loan fairly quickly. As in a fix and flip. Or fix your credit and refi. I think the long term risk is too high for me to sleep at night.
Its alsmost identical to a normal transaction. Two BIG exceptions:
1) The good one. No loan application or lender involved.
2) Not so good. You'll get a deed and title insurance that includes an exception for the existing loan. But its a normal warranty deed.
You want to be sure to disclose, disclose, disclose to the seller. Have a form saying they understand that the loan will still be in their name, will still affect their credit and they could end up with a foreclosure on their credit record if you default on the payment. And that they may have trouble getting another loan because this one will continue to affect their DTI.
Not all title companies will do these. Get in touch with investors in your area and find one that will.
Disclaimer: I don't do these transactions. I've gone through the paperwork and know how they work,but I don't do them.
Jon,
Thank you. The seller understands fully that the loan will remain in her name and all the risks you have listed. I still plan on having an attorney present at closing just to make sure her understanding is legally recorded. Would I need to have the deed signed over to my company name or can it be transferred to the individual?
who takes mortgage interest credit in such a case?
will the form still be sent out to original house owner (seller)?
is the lender notified?
The "grantee" on the deed can be you or your LLC, as you wish. Putting the property into an LLC may be desirable for asset protection.
Ownership is with the buyer. The owner gets the mortgage interest credit.
Get a Power Of Attorney from the seller giving you the right to deal with anything related to the property.
Various theories w.r.t. notifying the lender. Some claim if you notify the lender and they do nothing you're off the hook on due-on-sale. I don't buy it. Nothing is going to protect you from the due on sale clause. As long as interest rates are low and the loan is getting paid I doubt the lender will call the loan. If interest rates go up (I paid 9% on a 15 year owner financed loan on the first house I bought in 1987 and was VERY happy with that deal), rest assured these subject to loans will get called.
There is a lot of discussion here about subject to. Do a search on that term and you'll get a much more thorough discussion than I will give.
I think this may make sense if you have a plan to pay off the loan fairly quickly. As in a fix and flip. Or fix your credit and refi. I think the long term risk is too high for me to sleep at night.
Please be careful. As a lender, once I discover that the transaction has occurred, I would invoke my "due on sale" clause in the mortgage and call it. I just had this same situation happen on a mortgage that we had in one of our portfolios. A borrower has been vetted through the credit application process by the lender, but the new borrower that has assumed the loan has not. I see you are in VA. That is a deed theory State where the foreclosure process is pretty quick and relatively painless for the lender. If the lender discovers the transaction and has not given an expressed written approval, you stand to lose the property and your downstroke. I would just ask you to beware. I would hate to see you lose your investment.
That interest credit is a little bit of a catch 22. The old owner is still the Mortgagor. The Form 1098 will be issued in their (old owner) name. Not the name of the new owner. Without that form I am not sure one can take any deduction for the interest.
@Steven Hamilton II , what do you say about this? Can a Sub2 Buyer somehow get and take deductions for interest paid on a loan that is not their own?
Thats a bit over dramatic. You may well be the one lender who would do this. Most will not, at least not right now. If they do call the loan, its not as if they say "pay me off within 72 hours or get out." They still have to go through the foreclosure process if you don't pay them off. I do think you really should have some plan to refi the loan in case the lender does call the loan. And if rates jump and you have a bunch of these, yeah, you're going to be in trouble. Again, I don't do these, mostly because of this risk.
I'm curious to see what @Steven Hamilton II has to say, too. This has been discussed before, though, and I'm pretty sure the owner gets the deduction, not the official borrower.
Thats a bit over dramatic. You may well be the one lender who would do this. Most will not, at least not right now. If they do call the loan, its not as if they say "pay me off within 72 hours or get out." They still have to go through the foreclosure process if you don't pay them off. I do think you really should have some plan to refi the loan in case the lender does call the loan. And if rates jump and you have a bunch of these, yeah, you're going to be in trouble. Again, I don't do these, mostly because of this risk.
I'm curious to see what @Steven Hamilton II has to say, too. This has been discussed before, though, and I'm pretty sure the owner gets the deduction, not the official borrower.
To say that someone is "overly dramatic" on here is bad form. The poster was asking a question about a transaction in which he would breach a contract...in this case the note and mortgage. I think I answered this members question quite factually. The minute we discover that someone has assumed one of our notes without our permission, we'll call the note based on the due on sale clause. Virginia is a State that we do business in and it is a quick foreclosure State. It takes about 90 days to foreclose and it has no right of redemption. I'll also make sure to go after attorney fees. Some servicers may not be efficient, but the premise is still the same. There is a huge risk in assuming a loan without lender permission.
@Account Closed : Lots of good information here. Don't forget to take a close look at the note and DOT. The note for example may have a prepayment penalty, or there may not actually be a due-on-sale clause (unlikely). Also, you are going to have to do something about fire insurance, should the unthinkable happen you don't want proceeds going to the previous owner. Also, I've done a couple of these and every time the lender seems to send an over-payment refund check at payoff in the borrower's name, the POA comes in handy at that point. Also, maybe you didn't mean this literally but the seller doesn't sign over the note and deed of trust, actually, absolutely nothing happens to the note and dot, that's what sub2 is all about. It'll be interesting to hear Steve Hamilton's take on the interest deduction, the couple times I had a sub2 loan I took the deduction myself with no problem , I always figured he who pays it gets the deduction.
@David C. Thanks for the info. The insurance and tax aspects are the main elements of the transaction where I am a little foggy in understanding. I've been scouring past forums for specifics, and have come up with something to work off I think.
So, without being too repetitive, i think we all get the conundrum here - Sub2 is a contract entered into based on the breach of previous contract, UNLESS previous mortgage issuer is notified and issues explicit permission. Weather or not they will, is another question. What @Doug Smith said certainly makes sense.
The question of who gets mortgage interest deduction still stands.
FYI, spent last night digging with search function, and haven't found the answer. Lots on the mechanics of Sub2 though
If anyone is colleagues with @Steven Hamilton II, please PM him with this question and let us know what he says. The @message function on forums seems to not always work right now
@Account Closed
Does transfer of deed qualify as a sale of property or a sale of contract?
The "due on sale" clause needs to be specific, it seems, on what exactly is sold - deed or contract
@Doug Smith from everything I've read and people I've spoken with who really do these deals you are, by far, the exception and not the rule. From your profile it appears your company specialized in buying distressed debt and then modifying the loans or foreclosing and selling the property as a REO. From what you write here it sounds like if you discover a subject to deal was done with a property that is securing a loan you've purchased you use that as a basis to do the foreclosure. That's a perfectly reasonable business approach. But its a pretty specific niche. Most debt investors invest in mortgages for the payment. If the payment is coming in, at least for now, they're happy. Or so it appears when the question "do you know a loan being called" is asked. Yes it does happen. But only rarely.
Now, I'll repeat that if rates do go up and lenders decide they want to get out of low rate loans we will see much more scrutiny of subject to deals. The due on sale clause was put in specifically to allow lenders to get out of loans. Prior to that act, loans were commonly transfered and properties were bought and sold "subject to". Lenders were stuck with no ability to bail out when their security was transferred. So, if rates will go up I think we will see many subject to loans being called.
As far as "overly dramatic", in your first post you make it sound as if the buyer WILL lose the property if the lender finds out the property has been sold. That is simply not the case. While your company might automatically move to call the note, many lenders won't. Even if that does happen, the remedy the lender has is to foreclose. The buyer has several options at that point, including paying off the loan, selling the property or refinancing. The "lose the property and your downstroke" outcome is a possibility. But even if you were the lender and were unwilling to negotiation any outcome besides calling the loan the buyer has options other than "lose the property and your downstroke".
@Alex Baev specific language can vary in lender documents. The standard wording is quite specific, though. Any transfer of the property triggers the clause. A straight out sale. An option. A land contract. A lease longer than three years. All trigger the clause. Sorry, I have to run or I would find and post a link to the actual words. I'll add that when I get a chance.
The wording as to the due on sale is or can be in two places, the not and the DOT. A standard DOT states that no interest at law or in equity be conveyed.
Dion is correct as to the deductions, either party may take the interest deduction, the IRS allows it for whom ever actually pays the interest, it doesn't need to be the original borrower.
Yep, the due on sale applies, you can take your chances, be prepared to pay it off if necessary.
In a sub-2 you obtain a Special Warranty Deed, subject to the existing lien (mortgage) and it may be granted individually or to an entity. The sub-2 agreement may survive the closing dictating how amounts are to be paid to a second mortgage or lien, much like a contract for deed agreement or simply make a second mortgage.
Insurance is another matter off concern, making the old owner a lien holder on that policy is a notice to the underlying lender that a sale has occurred.
This is not an area to get instruction off the internet as a first timer, get with an attorney in your area and have them do the deal, it needs to be accomplished as customary for that jurisdiction. Good luck... :)
The question of who gets mortgage interest deduction still stands.
FYI, spent last night digging with search function, and haven't found the answer. Lots on the mechanics of Sub2 though
If anyone is colleagues with @Steven Hamilton II, please PM him with this question and let us know what he says. The @message function on forums seems to not always work right now
@Account ClosedDavid C., I think the logic that whoever pays mortgage gets deduction may not stand up in case of audit and accounting for expenses, hence my question. IRS may be forced to qualify these monies as a gift, or at best a payment on contract. But then the question is - is it "cost of goods sold" or "operating expense", since the sale may not have occurred per se?
Does transfer of deed qualify as a sale of property or a sale of contract?
The "due on sale" clause needs to be specific, it seems, on what exactly is sold - deed or contract
Alex: Checkout the California Fannie Mae Deed of Trust paragraph 18 at Fannie Mae Deed of Trust, exact due-on-sale language varies widely but all amount to about the same thing.
@Account Closed : Another reason to take a close look at the note and dot ... take a look at Q&A 5 at Due on Sale in Both Note and DOT, if the DOS clause isn't specifically stated in BOTH the note and dot it is unenforceable ... wouldn't that be a big pill for the quick on the DOS trigger lender to swallow.
Here's a link:
David, sounds like that may have been by counsel for the BOR, a legal opinion. The author seem to imply that loans may be made by an institution after the Act that may not contain a due on sale clause, not happening, all secondary market and insured banks include the DOS. While the author mentioned the reason being for market interest rates, that's only part of the story, it's an interest rate risk issue in lending funds long term, over a year.
As Jon provided the Code, it's not a requirement for any lender to accelerate any loan unless it is made by the institution in their written loan policy which is approved by regulators.
There are other issues at play as well, owner occupied vs non-owner occupied, death of the owner/borrower, or is the owner still in mostly the same position as when the risks were initially assessed? Transfers to immediate family are not significant nor when transfers are accomplished for estate purposes.
Frankly, if the lender takes action in a trust deed state, you're had, you'll need to sue to stop the foreclosure and it may not even be heard, if it is, you'll need to show there is no violation of the agreement as intended and as generally applied in that jurisdiction. If you sold any interest or leased for more than three years you'll likely lose that's in the Code. That's why most try to accomplish these deals using a few tactics, quietly. I have also gone dead ahead with notices of sale to lenders then relying on silence being affirmation or approval of the transaction, it's harder to change a policy if they accepted a years worth of payments then claimed discovery with a notice given a year ago.
Again, a local attorney needs to address such issues with both parties of a Sub-2 or any installment sale.
And, the notices and agreements of the note and deed of trust may guide the lender in either direction according to the terms. You can devise both so as to cover different issues or the same issues or both, and usually any default of a note is a default under the deed of trust as trustees rely on the powers of the deed of trust where they are appointed, not under the note. But the reason for action will be construed under which covenant was broken. As an example, a DOT may state that a lender may advance funds to pay insurance or taxes, but that may not be cause to accelerate the note to maturity, that is addressed in the note, or could be in both.
We also need to take care in arguing any such issues in this national (world) forum as state laws differ, but no state law prohibits or constrains any insured lender from rights available by the Code. So, like I said, you can take your chances.. .
@Bill Gulley : It's more than legal opinion, it's the law in CA, CC2924.5, DOS has to be in both the note and deed of trust or it's not enforceable. It seems to be an interpretation of US code 12 U.S.C 1701j-3(b)(2), but CA law nevertheless. I'm simply endouraging the OP to at least read the note and dot, they do sometimes have problems for the sub2 buyer.
@Dion DePaoli ,
Thank you for bringing me into this conversation.
@David C ,
The CURRENT owner gets the deduction as they are the one making the payment, this is also true because they have a financial interest in the property.
The seller cannot take the deduction as they are not actually paying it, therefore they cannot take it. You very well can take a deduction for the interest. You also should be acquiring the seller's amortization schedule for the loan to be sure you are taking into account the correct amount. You should also be arranging to have the 1098 forwarded to you. You can still use it even though it is reported in their name and SSN. You just may at some point have to prove to the IRS that you have a financial interest in the property and that you are making those payments.
Years ago, around '85 a contract for deed was made allowing the buyer to deduct interest that was done by an attorney. A call to the regional IRS office in KC, Mo. (phone calls aren't rulings, just advice) they said basically if someone is not actually paying the interest they may not take the deduction and the one who pays it is entitled. So be it. Fast forward '90/91, in this area and my office, it was customary to credit the buyer for interest paid.
The lender issued a 1098 by 12/31 of each tax year to the borrower and they were to forward to us or to the buyer. A new 1098 from the seller to the buyer was made, the bank's form was marked "installment sale" and sent in with the other 1098. They were identical. This was recommended by the local IRS office, so be it, it was done. Thousands were done in this manner and to my knowledge there were never any issues that I was ever questioned about.
That's not saying some buyer wasn't audited and had other tax issues that may have lead to some adjustment or action that could have involved the deduction, that I have no idea about but I never heard of any such issues concerning any buyer or seller.
Now, if a seller takes the deduction without paying it, what do we call that?
If a seller takes the deduction, they also need to declare the income as well, which they are to do in an installment contract, it may or may not be a wash, it depends on the interest charged by the seller that wraps the existing loan. In that case the loan interest is an expense and the overage is income.
There were a few issues that came to my attention when both the buyer and seller took the deduction, mostly they forgot how to treat the matter prior to filing, a few too after they filed, my instruction was to file a correction, I have no idea what they did.
Not sure when we implemented the disclosure; "Your Responsibilities In Your Installment Transaction" but it addressed taxes, deductions, occupancy, insurance, payments and escrows as a brief outline to the obligations and expectations of buyers and sellers.
I'm not a tax guy, but I am an accountant and this is a proper allocation of funds relating to installment contracts. It's been done without a hitch for decades. :)
I am looking to purchase subject to? Do I go through an agent to find such deal or should I look for that deal myself?