Back in 1978 (I don’t want to know how many of you weren’t even born yet) my husband and I bought our very first house and we bought it the only way we could qualify; by assuming the existing financing. Assuming a loan was not only very easy, but the common practice in those days. The house was $100,000 – the seller’s balance was $40,000 – so we were able to take that over and had to come up with only the remaining $60,000.
Those were wonderful times. But wonderful times have a way of fading into a memory. Interest rates were soaring, and one fateful day the lenders woke up and thought, “Wait a minute! Homebuyers are taking over loans we’ve already created at lower interest rates. If we stop letting them assume those lower rate loans, we’ll make a fortune!!”
(Early 1971 interest rates were around seven percent and continued to increase to a peak in 1981 of more than eighteen percent.)
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Subject-To Wrench in the Gears: The Due-on-Sale Clause.
Originally, loan assumption was a state issue and many states continued to allow loan assumptions and disallow due-on-sale enforcement unless the banks could prove that the purchaser could not qualify to make the payments. In 1982, however, the Garn-St. Germain Depository Institutions Act made due-on-sale clauses a federal issue which struck fear in the heart of both buyer and seller.
Very quickly, the banks ran themselves right into the ground. Buyers could not qualify for the entire loan meaning sellers could no longer sell their homes meaning banks began getting properties back at an alarming rate. Sound familiar? This is not the first market to see banks create a housing crisis.
Even though lenders no longer work with buyers and sellers allowing loan assumptions, acquiring properties subject-to existing financing continues. Yes, it is legal. It shows up on the HUD1 on lines 203 and 503.This is an excellent way to acquire properties anytime the seller agrees to sell by transferring title to the property while leaving the financing in their name. Interestingly, we get very little push-back from homeowners when we present the facts for this type of transaction. That surprised me in the beginning; now I take it for granted.
And, we don’t have a problem from the lenders. They have so many non-performing properties on their books that they’re happy to get a payment and don’t necessarily care who it comes from. We have received letters from lenders stating that they’ve seen a change in the insurance premium and a change on the title so, while they’re not sure exactly what is going on, they want us to continue sending payments to “x” address. I’m pretty sure they know exactly what’s going on, it’s simply a matter of don’t-ask / don’t tell.
We did have one Credit Union call to say that they wouldn’t allow us to take over their existing financing so they were calling the loan due. Jim had a conversation with as many people up the ladder as it took to convince them that they had a performing asset on their hands and we were good for the loan. They let us continue and have not contacted us again since.
Source of Concern:
So, if the sellers are ok with subject-to and the lenders are thrilled to keep the asset performing, where’s the problem?
It’s the prosecutors we worry about. There are far too many hungry attorneys looking for ways to feed their families. If a seller comes back at a later date and wants “their” property back, many attorneys are only too willing to go to court in an attempt to prove the investor stole the property from their unsuspecting seller. We know several investors who spent as much as five figures in court defending that what they’d done when taking a property subject-to was perfectly legal. They were ultimately found not-guilty of any wrong doing, but nevertheless spent funds to prove their innocence – over a year of their time – and untold emotional aggravation. As a real estate investor, you are absolutely guilty until proven innocent…
* What’s the message in this story? Never “convince” a seller to sell to you this way. Make sure your seller is thrilled that you have a way to solve their problem and that they are only too happy to do whatever it takes to make the transaction work.
In our state, we have the added concern of an Attorney General who is, naturally, angered by “scammers” who take properties subject-to and don’t bother to keep up the mortgage payments, as well as any who attempt to conceal the transfer and not pay transfer taxes which our state requires. We do not conceal any part of our transaction and we do pay transfer tax on all properties we take subject-to. To say our Attorney General is not a fan of subject-to is an understatement. In our business practice, subject-to mortgages are the mortgages that are the MOST important to pay. Make sure they’re your top priority as well.
And So the Good News…
Transferring title to a property secured by a “due-on-sale” mortgage is not illegal. Turns out, there is no federal or state law which makes it a crime to violate a due-on-sale clause. The due-on-sale clause gives the lender the right to demand payment of the remaining balance of the loan when the property is sold. This is a contractual right, not a law. The lender has the “option” to call the loan but is not required to do so. In our experience and the experience of many, many investors across the country, lenders prefer to keep a performing asset on their books rather than risk the time and expense of foreclosure and holding a non-performing asset.
Besides, why would the HUD1 closing document contain appropriate spaces if it were a crime to take property subject-to an existing loan?
As I’ve emphasized, lenders seem to prefer keeping a performing asset on their books rather than exercising their option to call the loan due.
* Big Word of Caution however. – Once interest rates start jumping, all that may change. If you’ve taken over low interest rate loans, pay special attention to climbing rates and be prepared to refinance or pay it off if needed.
We remain very conservative and cautious when buying this way. But, when done right, subject-to purchases are a legitimate way to buy properties and work well for both the buyer and the seller.
Are you willing to take a property subject-to a mortgage containing a due-on-sale clause?