Subject To Real Estate: Why Investors Should Add This Tool to Their Arsenals

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Way back when, I used to have an I Buy Houses” business. I would act as the bank for a few birddogs who were steadily feeding me deals. In those days, “subject to” was one of my favorite strategies for buying properties from motivated sellers.

It was a very valuable tool for me back then, and I actually still use it today on a much grander scale. Notice I said it’s a tool of many that I utilize when dealing with a potential seller. If there’s anything that I’d like you to take away from this article, it is to use the right tool for the right job.

When I was aggressively looking and marketing for real estate deals, it wasn’t about what I knew how to do. I didn’t say to myself, “I want to learn how to do subject to deals and go out and look for them.” I learned about subject to (from the likes of William Tingle, Peter Conti, and David Finkel). Then I put that tool away in my arsenal to pull out when needed, along with my other tools — including cash offers (with private or hard money), owner financing, and lease options.

Like I said, there is a time to use and a time not to use each of these strategies. For example, if an owner owes more than a property is worth and it needs a lot of work, I’m usually not doing a subject to deal. Or if a lease option needs a good bit of work, I would not do the work without getting the deed.

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What is “Subject To” Real Estate?

First of all, what does buying a house “subject to” really mean? After all, there are all types of subject to clauses one can put into a contract when buying a home. This includes subject to attorney review, buyers inspection, finding a quality resident (as in a lease-option), or as we’re referring to today, the existing mortgage.

In the beginning, this was a tough concept for me to understand. I wondered, “Could I really just take over someone’s mortgage payment on their original loan, and they’d transfer me the deed?”

The answer is yes.

subject-to

Why Would a Seller Be Willing to Sell Subject To?

This was probably the toughest thing for me to get. Why wouldn’t the seller just sell the home? Why would they give up equity or title? Why would they jeopardize their credit?

As I did more deals and worked more with distressed sellers, I soon discovered the why. Unfortunately, bad things happen to good people, and sometimes they get themselves into tough situations or they just plain run out of time.

Related: Why Real Estate Investors Should ALWAYS Verify Seller Information

The first subject to deals I did were while I was practicing as a real estate agent. One was a single residence in a nice family neighborhood, and the guy wanted to retire to his vacation home in another state. The property needed a lot of work, and it looked like the hoarders had lived there. The seller and I had tried to sell it, but we just couldn’t get a good enough number for it. It was then that he agreed to sell it as a subject to deal to my contractor buddy. It turned out to be a win-win situation for everyone.

Subject To Advantages for the Seller

The seller was able to walk away and retire immediately. He didn’t have to wait to sell it, he didn’t have to clean it out, he didn’t have to fix anything, and he didn’t need a home inspection, a certificate of occupancy, or a termite report. He just took what he wanted and left. In fact, he didn’t even pay any Realtor fees or normal closing costs because I agreed to let him take it off the market since my contractor buddy would let me list the “pretty version” of the house.

In fact, the seller wasn’t even worried about the contractor paying on the mortgage since they both had access online to see if the loan payments were made. The contractor also had a history of doing these types of renovation deals in the past, and besides, the seller said he may never need his credit to buy another place in the future anyway.

Subject To Advantages for the Buyer

The advantages for the buyer were numerous, too. He was able to pick up the loan payments on a favorable spot of the amortization schedule (where the P+I payment is more P than I), and he got all of the tax advantages, low closing costs (similar to a cash deal with no lender points and fees, appraisals, etc.), a quick closing (but still needed title insurance), and a better interest rate (since it was an owner-occupied loan at origination). He didn’t need to qualify (it didn’t show on his credit), and he didn’t even have any personal liability on the debt. The beauty of it was he was able to get long-term financing without ever talking to a bank.

subject-to-real-estate

The Pitfalls of Subject To

By now you may be thinking, “What’s the catch?”

And you’re right. There are things to be cautious of (remember what I said about having the right tool for the right job?).

I referenced getting title insurance when purchasing a subject to deal because one risk is any existing liens. So, be sure to pull title and utilize a good real estate attorney in your state, especially for the first time around.

There are some additional pitfalls as well.

The Due on Sale Clause

There’s no doubt that the due on sale clause can potentially be one of the biggest pitfalls. This is a clause in the original loan documents of the seller. In essence, it says that if title is transferred or changes hands, the bank has the right to call the loan due and in full. Keep in mind, I said “right to call the loan,” but the real question is how often do they?

As someone who has done too many subject to deals to count over the years, largely due to foreclosing from a junior lien position, I can only recall one time where a bank would not allow us to reinstate a first mortgage (thus calling the mortgage due), and it was because they knew the borrower was deceased.

Related: How to Choose the Best Source of Funding for Your Next Real Estate Deal

In another instance, I had a friend who took over a local home subject to, and she made it a rental property. The mortgage company sold the loan to a third party, and then the third party called the loan due since they had noticed that it had transferred hands and that there also was equity in the property. In this case, my friend just refinanced the property and paid the lender off. So it is good to be aware of this possibility and have reserves or access to cash if this situation should occur. But also keep in mind that the lender would have to take you all the way to foreclosure, and that’s usually plenty of time to sell or refinance the property (timelines vary by state).

In this type of situation, it wouldn’t impact my friend’s credit, but it could impact the seller’s credit. In this case, the original seller already had pretty banged up credit from a divorce, but that’s not the point. You really don’t want to make it worse if you can help it.

Insurance

Another issue may be determining who should insure the property and if a change in the insurance policy would trigger the bank to exercise the due on sale clause.

The best advice I’ve gotten on this was from my buddy, Tim Norris (from the Affinity group), who said that the owner of the property must own the policy. Also, leaving the seller’s policy intact and just getting another one for the new buyer, thus having two policies on the property at the same time, is probably not a good idea since you might have a situation where both insurance companies would be trying to deny a claim if one were to occur.

It’s probably easier to have all parties named as insured or additional insured on the one policy, including previous and current owners.

The only other potential pitfall I can think of is if you should need a seller’s signature down the road. In my first example, my contractor buddy cleaned out the property and fixed it all up. I then got to sell the newly renovated property to a nice family. (Plus, I got to make an even larger commission than I would have if I had sold the property in “as is” condition for the original seller.)

The seller got to move out of state and enjoy retirement right away. But since the seller had moved far away, it was also good that my buddy had gotten the limited power of attorney from the seller, which enabled him to sign things on behalf of the seller in regard to the property. This became very relevant when things like the return of mortgage escrow check from the seller’s bank came in after the sale of the property.

As you can see, there are many advantages for the buyer of a subject to deal, beyond not needing hard money, as well as lifestyle and financial advantages for the seller. I strongly recommend adding this tool to your tool belt.

So, let me ask you, what were some of your best subject to deals?

Leave your questions and comments below!

About Author

Dave Van Horn

Dave Van Horn is President at PPR The Note Co. - an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

29 Comments

  1. Ryan Sanders

    Great article! I still haven’t found my first deal and am very new but I really like this concept. I have read a few more blog posts here on BP about sub2, but everything seems pretty dated (2013 and prior). Has there been any new(ish) legislation that could throw a wrench into this investing strategy?

  2. Jerry W.

    Dave,
    As usual an excellent article. You are one of my favorite blog writers. You seem to have an in depth knowledge and experience in nearly every facet of real estate. Thank you for taking the time to share your knowledge. I did my first subject to about a year ago on a property that was upside down with two mortgages and involved a divorce as well. My brother asked how a deal could be done with all of the factors. We eventually got the deal done and are now refinancing the property to get the property out of the Seller’s name. the property does not have that big of an equity position, but the rent to price ratio is pretty good. is a joint venture with one really good benefit, my brother does all of the managing and takes care of the books as well. I literally got into the deal for about 20 hours of work doing documents and research.

    • Dave Van Horn

      Thanks Jerry as always! As long as the tenants keep paying, sounds like you’re in a good spot. Plus it’s hard to beat any kind of return from an investment that only requires 20 hours of work into the deal. Congrats on your success!

      Best,
      Dave

      • Mr. Van Horn said, “I wondered, ‘Could I really just take over someone’s mortgage payment on their original loan, and they’d transfer me the deed?’ The answer is yes.” So the jeopardy comes in because even though the seller has transferred title to the buyer, he is still on the hook got the mortgage payments. The seller jeopardizes his credit when the buyer turns out to be unreliable about paying the mortgage, right? This seems like a bad idea for any seller. It seems a subject to buyer should expect the seller to retain the deed until the buyer’s obligation is fulfilled. And yet Mr. Van Horn suggests that this is not how it works. On what assurances would any seller be willing to take such a gamble on a stranger?

        • Bill Walston

          Often @Katie, it’s because the seller is more concerned with getting rid of a problem property than potential problems with his/her credit. You’d be surprised at the number of sellers willing to transfer the deed “SUB2.”

  3. Michael Borger

    I do quite a few of these in Hawaii. I love being able to reduce the finance cost of a project while at the same time helping to bring up a seller’s credit score by making their payments on time. It works out well for both parties.

  4. David Burdick

    Good article Dave. As an insurance agent specializing in serving property investors, I would also suggest changing the mailing address on the original owner’s insurance to you before canceling it. This prevents a check from a claim made by the original owner against his original policy being sent to him and legally cashed without repairs being made. I am aware that some investors have stepped in this trap. Also a power of attorney will allow the new owner to proceed with repairs and apply the payment in the event this happens.

  5. Rene Casey

    So glad I found this blog! Thank you for sharing D
    your knowledge and experience Dave. My brother and I have been studying Marko Rubel investing strategies which include sub2. We live in Texas and have consulted with an attorney who said it can be done here but laws are very strict here for selling with financing included and for lease options. He recommended buying with conventional financing but again said we could do subject to deals but… Title companies here say they can’t close a sub2 deal because they can’t write a title insurance policy for the new owner. Wouldn’t the current title policy suffice since the lender us staying the same? I mean as long as the seller is still the only owner of the property when he agrees to sell to you, right? Does anyone know of an attorney or title company who can close a sub2 deal in Texas, preferably Dallas/Ft. Worth area? Thank you in advance,
    Rene

    • Dave Van Horn

      Hi Rene,

      Thanks for the kind words. Appreciate you chiming in.

      In most states you can get some form of title insurance but that can vary by the policy and the state you’re located in. It also depends on how you plan to exit your deal.

      For us, when buying Sub2, in most cases we only did a a “quickie” title (or a present owner search) if any, to determine if any liens or judgements occurred during the current ownership. You also want to determine the status of the owner’s current mortgage before taking it over.

      Best,
      Dave

      • Rene Casey

        Thank you for your reply, Dave. For an exit strategy we plan to sell retail. We would like to do lease options but are considering rentals with a property management company handling operations. I agree with the “quickie” title search as long as a current title policy exists. You are so right about the current status of the mortgage also. Liens would need to be checked also. Is there a state where it is much easier to do subject to closings? Thank you.

        • Dave Van Horn

          Hey Rene,

          Apologies for the delayed response, just saw this.

          To my knowledge there isn’t a state that’s particularly easier than another. Most mortgages are written by the top banks in the country and between these, they tend to operate in all 50 states. Although the Real Estate transaction may be state specific, I don’t think there is anything state specific in regards to the loan documents and “subject-to”.

          You could also check with a local Real Estate attorney to confirm.

          Best,
          Dave

  6. When the seller have an escrow servicing account, can they cancel it? Because I would prefer to make the payments on my own directly, versus having an escrow account…. Or would the payments still be the same either way? Im leaning towards getting a house under a sub-to only because the seller relocated and I got a tenant/buyer in place. The house have no equity, it’s a newly built newly purchased by the sellers, then they relocate 2 months later to get their dream jobs out of state. Their P&I is $961, taxes at $88 and escrow servicing at $389 so total pmt is $1348 or so. But my tenant/buyer wants to do a lease purchase at $1,475-$1,500… I know it’s not much, but this tenant/buyer really likes it…. so, my question is… is using an escrow servicing account the same pmt as when I would pay it directly on my own? Also, how often do property taxes becomes due, is it a monthly due or just one time annually?

    • Dave Van Horn

      Hi Jennifer,

      In the scenario you described, you’re not assuming the mortgage, you’re taking over subject-to the original mortgage. So with that being said, the escrow needs to remain intact otherwise if you doing anything to raise a red flag (like an attempt to pay direct) could trigger the bank to the call the loan in full.

      As for property taxes, they’re due yearly but they’re due at different times. The local and county in are typically announced in the Spring while the school taxes come out in the Summer. But keep in mind when the original buyer purchased the home, they escrowed approximately a year’s worth of taxes and insurance in advance which the bank escrows on behalf of the borrower in case of default. So you would be paying approximately 1/12th of the taxes and insurance (plus a small cushion) every month in your escrow portion of the mortgage payment.

      Best,
      Dave

  7. Percy N.

    @Dave van horn,
    Could you please expand on the tax benefits for the buyer?
    Since the seller is the one getting the 1098 from the mortgage company, wouldn’t the seller get the benefits? If escrow is used for taxes, that complicates things even more, doesn’t it?

    Thanks
    Percy

    • Dave Van Horn

      Hey Percy,

      Sure thing. Although I’m not an accountant, in this scenario I described above, the buyer is now the owner of the property, has the deed, and makes the mortgage payments. Therefor the buyer gets the deductions and depreciation, not the seller regardless of who the 1098 is made out to. This is because the seller cannot deduct the interest on a mortgage for a house they no longer own.

      Using the escrow for taxes doesn’t usually complicate things. The only potential complication that could arise would be if/when the new buyer decides to sells the property – this is because there is a return of any remaining escrow. The concern is the check would be made out to the previous seller since that’s who the mortgage company recognizes. BUT, this is why I mentioned the limited Power of Attorney in the article since it would allow the new buyer to sign for things that pertain to the property, like the return of escrow check.

      Best,
      Dave

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