Would it be crazy to do a subject-to deal on an house underwater?

[Audra Berger]

Scenario -

Sellers bought house in highly desirable neighborhood in Phoenix, AZ at peak of last crash.
They still owe $650K. The home is worth between $595-610K. ARV could be right around $650K. Home is 5 bedroom.

Sellers currently live out of state and have tried to make this work with rentals, air bnb, etc. But have not managed well, and this second mortgage is a major stressor in their lives.

They did a loan modification in the past so they actually have a very low mortgage payment given the size of the debt at $1900. They are currently renting it ($2200) way under what it could rent ($2700-3000).

Would it be crazy to offer a subject-to for a fully furnished home, have them cover closing, and be into a $600K house with no money out of pocket even though it is under water $40-50K?

Pro's - (1) No money out of pocket and we have money in reserve to cover vacancy and do repairs. (2) It is in one of the best neighborhoods in the area. (3) The mortgage payment is low enough that it can cash flow just fine. (3) We can aggressively pay down the debt with cash flow. (4) Would there be tax advantages?

Con's - (1) Your obviously starting out WAY underwater, (2) the house is not the sweet spot for renting given its size and price range, (3) uncertainty about rent and homes value given the circumstances.

I would appreciate any expert advice. This would really help the seller, and viewed long-term, could be profitable especially with no money up front.

[Account Closed]

@Brett Berger easy answer: do you have a tenant/buyer lined to cover the cost?? That is the biggest question. Forget the amount of the loan, focus on the payments, and what tenants/buyers would be willing to pay.

[Patricia Steiner]

What makes you think they can cover the closing costs? And, is the mortgage assumable? No lender is going to finance more than it's worth.  I'm not sure what your proposing is realistic.  Financially I don't think it sounds like a great opportunity; it kind of sounds like you love the house - which is not a good investment strategy.  

My recommendation would be to do what successful investors do every day:  buy within valuation (that buy low, sell high thing).  It's hard to overcome a bad buy and you don't know how long it will remain underwater and what maintenance was never completed because they didn't have the money to do any of it.  

[Darius Ogloza]

I do not see how your proposal would "really help the seller."  Assuming that the mortgage payment of $1,900 includes property taxes and insurance, I do not see how they would benefit from handing the property to you (and pay costs, as you indicate) when you cannot promise them real repose through this kind of deal (i.e. they will legally remain on the hook for the payments regardless of whatever arrangement they have with you)?  Do you intend to assume the mortgage?  Is it assumable?  Their rent is covering their recurring costs for the time being - what do they gain by accepting your proposal?  

[Audra Berger]

Thanks Patricia and Darius! Those are just the kind of critical questions I was looking for. I don’t know a lot of the details of the financing, etc. These are mainly the ideas I wanted to vet based on a conversation I had with a friend last night. Exploring possible solutions. So, to Patricia’s point, I don’t love the house; I love the seller. But, that is also not a reason to do a bad deal. 

I know the principle of buy low/sell high. Just wondering if you don’t have any money in or a very little, can you rehab a bad situation? Like those that buy an underperforming business and turn it around.

To Darius’ point, assuming we can even assume the financing, I know in one sense, they are not completely free of that financing for a while till we could sell it, but perhaps it would be psychologically freeing that they don’t have to worry about managing it from across the country.

Question, what would be another solution? Is there one? Perhaps just help them manage the rentals better for a PM fee?

[Wayne Brooks]

A really bad idea....loans that have been modified get more scrutiny than others. Any change in the insured or anything else indicating a title transfer will get the loan called due. 

[Account Closed]

Originally posted by @Audra Berger:

Scenario -

Sellers bought house in highly desirable neighborhood in Phoenix, AZ at peak of last crash.
They still owe $650K. The home is worth between $595-610K. ARV could be right around $650K. Home is 5 bedroom.

Sellers currently live out of state and have tried to make this work with rentals, air bnb, etc. But have not managed well, and this second mortgage is a major stressor in their lives.

They did a loan modification in the past so they actually have a very low mortgage payment given the size of the debt at $1900. They are currently renting it ($2200) way under what it could rent ($2700-3000).

Would it be crazy to offer a subject-to for a fully furnished home, have them cover closing, and be into a $600K house with no money out of pocket even though it is under water $40-50K?

Pro's - (1) No money out of pocket and we have money in reserve to cover vacancy and do repairs. (2) It is in one of the best neighborhoods in the area. (3) The mortgage payment is low enough that it can cash flow just fine. (3) We can aggressively pay down the debt with cash flow. (4) Would there be tax advantages?

Con's - (1) Your obviously starting out WAY underwater, (2) the house is not the sweet spot for renting given its size and price range, (3) uncertainty about rent and homes value given the circumstances.

I would appreciate any expert advice. This would really help the seller, and viewed long-term, could be profitable especially with no money up front.

I have a lot of experience doing Subject To. Phoenix is at the height of the market right now and it would seem taking on an underwater mortgage is pretty risky. The loan modification you speak of is probably a 2nd that you have to add to the amount to pay of the original financing. I could see this working if your intention is to live in the house for the next 5 to 10 years, but nothing about it says "buy me" for an investment.

[Account Closed]

Originally posted by @Wayne Brooks:

A really bad idea....loans that have been modified get more scrutiny than others. Any change in the insured or anything else indicating a title transfer will get the loan called due. 

I change the insurance in all of my Subject Tos to include my LLCs and have never had one called as a result. I close in escrow and have the deed recorded, too. It's foolish to do otherwise.

[Theresa Harris]

If you want to buy it and the numbers work, just buy it and get your own mortgage.

[Kerry Baird]

As long as you are clear that you are buying for the cash flow, and you need to manage that better than the seller has done, it has possibilities.  Yes, you'd have to do a subject to deal, and not assume, nor get a new mortgage.  You need to know the interest rate, whether it is adjustable or fixed...establish how far you are through the amortization schedule, where the principal starts getting paid off faster, vs the interest.  Tenants pay off the mortgage over time, as usual. 

You set aside funds for repairs and maintenance.  You get an inspection so that you know what exactly is wrong with the property.

And YOU are stuck in an upside down mortgage situation, that produces monthly cash flow.  It could happen to many of us who have bought in the past year or so, and what would we do?  Not worry about it.  Keep the house occupied; keep paying down the mortgage.  

[Nicholas L.]

@Audra Berger setting aside the whole subject-to issue, you already answered your own question with con #2: "the house is not the sweet spot for renting given its size and price range."  It's still debt.  Why not find a property with a better rent to purchase ratio?

[Account Closed]

So what would stop you from stopping payment on the mortgage and taxes, collecting the rent for as long as you can and letting it go to foreclosure? Your credit is not on the line and you have zero cash invested. In other words why would the current owner take a risk like that? 

[Brett Goldsmith]

I think it's a horrible idea to buy a house that's upside down 99% of the time. Only way it would make sense if it there was some large value add play. You should be looking to purchase it as a short sale. In real estate you typically make your money when you buy. You want equity from the get go.