Subject to real estate is undoubtedly one of the most strategic approaches you can explore when investing in real estate. If you're unfamiliar with the term “subject to mortgage” or the broader concept of “subject to” in real estate, you're in the right place.
In real estate investing, buying properties subject to the existing mortgage (often called “sub to contract”) is a creative financing strategy that allows investors to acquire property without having to qualify for a loan themselves. If you've ever wondered, “What is subject to in real estate?”, this guide will walk you through everything you need to know.
This guide aims to equip you with the necessary understanding, and for your convenience, we've included a subject-to-real-estate step-by-step guide, examples, sub-to-real estate contracts, and a comprehensive checklist.
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"Subject to" real estate refers to the transaction of a property while maintaining the integrity of the existing loan on the parcel. If you're looking to understand how to buy a house subject to, this approach allows the investor to acquire the property without having to secure a new loan.
In subject to real estate, the investor purchases the property and agrees to make payments on the existing loan of the house. The seller gives the title to the real estate investor.
This loan stays in the seller's name, but the buyer makes the mortgage payments on behalf of the seller, and the lender does not know about the property's transaction.
When you engage in a "subject-to" real estate transaction, you essentially purchase the property while leaving the current mortgage intact.
This arrangement means that, as the investor, you shoulder the responsibility of the mortgage payments, even though the loan remains formally under the seller's name. The seller transfers the property title to you, but interestingly, the lender remains unaware of this transition.
This can be compared to a relay race where you, the new runner (or buyer), take the baton (property) from the previous runner (seller), continuing the race (mortgage payments). The original runner remains the officially registered participant, but you're now driving the pace and direction.
The seller benefits twofold: Firstly, they find reprieve from their mortgage obligations, which can be particularly beneficial in scenarios of looming foreclosures or financial duress. Secondly, they receive any agreed-upon difference between the property's market value and the outstanding mortgage amount.
From the buyer's perspective, this strategy can offer properties at attractive prices, potentially below market value, and often with established favorable loan terms.
However, it's important to note that the buyer needs to consistently honor the mortgage payments to prevent foreclosure since the property title is now in their possession.
For example, imagine traditional property sales as clearing off the entire mortgage at once and "mortgage assumption" as formally transferring the mortgage responsibility.
The "subject-to" strategy, on the other hand, operates in a grey area between these extremes. While there's typically no binding agreement detailing this setup, the repercussions of non-payment can be dire for the buyer, emphasizing the inherent responsibility this strategy demands.
Different “subject-to" strategies offer a particular niche that can be beneficial when understood deeply. There are primarily three kinds of "subject-to" real estate transactions:
Let’s dissect each one to better comprehend their dynamics.
The most prevalent type of "subject-to" transaction, a Cash To Loan Subject-To, involves the investor paying the seller in cash for the difference between the property's current value and the outstanding mortgage balance. The investor then assumes responsibility for the remaining mortgage payments. In many situations, properties under this transaction type are nearing or already in foreclosure.
Cash To Loan Subject-To Example:
A seller carryback subject to is the second most common form of a subject to. You're likely to have already heard of this type, just in different terms. This type of transaction is often called "owner financing" or "seller financing."
This works as an additional form of financing to be used if the investor's lender won't allow them the total funding that is needed for the purchase of the property.
The investor will get a mortgage for as much of the property's value as possible and then make payments to the lender in the form of a traditional mortgage, as well as payments to the seller in the form of a seller carryback, subject to.
The seller never gives the investor the difference in cash. Rather, they are not paid in full for their house and instead slowly receive the difference in payments directly from the investor.
The seller is in control of the terms of this transaction. They generally control the interest rate, downpayment, and loan length. Usually, the original homeowner wants the investor to put down a downpayment of five to twenty-five percent and pay off this portion in five years or less.
The official mortgage with the lender can take much longer to pay off and will likely be on different terms with different stipulations, down payments, etc.
Seller Carryback Subject To Example:
The most intricate of the three, the wrap-around transaction, sees the buyer paying an interest rate derived from the original mortgage's rate but with an added premium. This ensures the seller can meet their own interest commitments to their original lender. This type can be more challenging for the buyer if the base interest rates are high.
If the original homeowner's mortgage is 4%, the seller will likely ask the investor to pay 6% on the carryback. At low interest rates, this isn't much of an issue. If, however, the seller had a higher interest rate, then this is not an ideal situation for the investor.
Wrap Around Subject To Example:
Finding properties suitable for subject-to-transactions isn't all that different from sourcing regular real estate deals. The challenge is pinpointing homeowners willing to consider this non-traditional transaction.
Below are some tried-and-true methods to discover Subject-To opportunities:
In today's digital age, several online platforms can aid you in identifying potential Subject-To properties. These websites are treasure troves for real estate enthusiasts, showcasing a plethora of listings, including those in distress.
Real estate agents can be a treasure trove of information. Some have networks specifically catered to distressed properties or can point you in the right direction.
Real estate wholesalers typically have access to pre-foreclosure listings and can connect you with homeowners eager to sell.
Local real estate lawyers and attorneys often have knowledge about properties in pre-foreclosure or going through legal proceedings. Establishing a relationship with them can open doors to potential Subject-To deals.
Local newspapers are mandated to publish addresses of properties under foreclosure. This might sound old-fashioned, but it's a time-tested strategy to identify properties in distress.
Consider implementing a targeted real estate direct mail strategy. Craft well-thought-out letters or postcards expressing your interest in buying properties via Subject-To deals.
Zero in on neighborhoods or properties that appear distressed or vacant.
Driving for dollars involves driving around neighborhoods and scouting for properties that appear vacant or distressed. In doing so, you can find unexpected opportunities.
Engaging directly with homeowners gives you the chance to explain the potential benefits of a Subject-To deal, especially if they're in financial trouble.
Subject-to real estate provides an array of benefits, easing the process for both investors and sellers but not without carrying some risks. Here's a deep dive into Subject-To’s benefits and drawbacks:
The subject-to transaction allows buyers to purchase property without getting a new loan. This strategy requires meticulous attention to detail. Whether you're a seasoned investor or a newcomer, understanding how to execute a Subject-To deal can be a profitable venture.
Let's deep dive into our 10-step guide that will cover the process and set you on the path to mastering subject-to transactions:
Finding a distressed property owner is the foundational step in a subject-to transaction. These homeowners are typically facing financial hardships, making them more inclined to consider unconventional selling methods.
For your reference, here are the resources we mentioned above to kick-start your search:
Approach the situation with empathy and professionalism. Remember, the homeowner might be going through a difficult phase, so always lead with kindness, understanding, and respect.
Identify the root cause of the homeowner's predicament to gauge their eagerness to sell.
Inquire about essential details such as the lending institution, outstanding loan amount, monthly mortgage payment, and any overdue payments. Additionally, gather information about potential tax liens and mechanic liens on the property.
Ensure the homeowner provides you with an "Authorization to Release Information" form. This isn't a tactic to question their integrity but is crucial to validate the data they've shared. By doing so, you can guarantee that you present them with the most equitable and optimal offer for their residence.
Begin by determining the after-repair-value (ARV) of the property. Estimate the rehabilitation expenses and chalk out your prospective exit plan.
Evaluate the prospective property in relation to its neighbors, considering its current state and potential post-renovation.
Conduct a comprehensive sales comparison analysis, ensuring you adjust for differences in property attributes such as amenities, square footage, and the number of rooms, specifically bedrooms and bathrooms.
Define your endgame. Are you looking to resell the property at a profit, convert it into a rental unit, or explore a lease option? For a resell, benchmark against recent sales in the vicinity. If considering it for rental, assess local rental rates. And if opting for a lease, compare terms with nearby lease agreements.
Get permission from the homeowners and then visit the house. This will fill in the blanks on repairs you'll need to make, the condition of the property, and how long it will take you to fully rehab the home. Take pictures if you've been given permission, and don't forget to bring your checklist. We'll provide you with that checklist down below.
If you can get a home inspector to tag along with you, that's even better.
After your visit through the property, you may need to revisit step three and adjust your estimates.
The experienced investor knows to never, ever skip this step. This isn't exactly a fun part of real estate deals, but it is crucial to protect yourself and ensure a smooth, profitable sale.
If you haven't already, get the seller to sign an "Authorization to Release Information" form. Once this form is signed, call their lender and fax or email this form to them. After they see you have the authorization, the lender will give you lots of really important information regarding your potential new property.
Next, have a title company run a preliminary title search. This will tell you who the complete list of owners are, and if there are any liens or owed taxes on the property. During this search, you may find that tax liens, mechanics liens, HOA liens, code enforcement liens, or Federal IRS liens are owed against the property.
Then, you should also call all of the local utility companies to get information on the property. Utility companies you should be checking with to see if there are any past-due bills include:
After checking on the utilities, check the property tax amount. This will let you know when and what to expect to pay in property taxes once the parcel is yours. It will also let you know if the current homeowner is behind on any of these taxes and how much money will be owed once you make the purchase.
Anticipate various expenses associated with acquiring the property to ensure a smooth transition. Potential costs you may incur include:
Using all of the above information that you've gathered, make a fair offer to the homeowner for their property.
It's always a good idea to have a real estate mentor or real estate attorney help you draft an offer. They can accurately tell homebuyers if the existing loan balance is appropriate and what a fair purchase price should be.
For this step, you need a purchase document that is enforceable in your state. At the bare minimum, have your subject-to-agreement checked by a real estate attorney. Better yet, have your attorney write up the subject to document for you.
Your real estate attorney is already knowledgeable about loan terms, a fair sales price, and how to make a proper loan assumption. They are good people to have on your team.
Depending on the state, you can finalize the property transaction at home with the seller, at a title company, or with a closing attorney.
While "kitchen table" closings are valid in some states, they are almost never a good idea. It's wise to stick to attorneys and title companies for the most financial safety.
Most closing documents will need to be notarized, which is why kitchen table sales are such a bad idea. All owners will need to present to sign the documents, and that includes spouses. If an owner has died, a death certificate will likely be needed to make the transaction.
At closing, you will receive your new investment property's keys.
First, you will need to cancel the seller's insurance. Use your limited power of attorney to change the mailing address to your address, and then cancel their homeowner's insurance policy.
Next, you'll need to obtain your own homeowner's insurance. You should always have your own policy on the house to ensure that you are never denied a claim. This can happen if the primary insured person is not the owner.
When you create your new policy, make sure that you get a non-owner-occupied landlord policy. You need to be the first name listed on the insurance, and then the existing mortgage company as the mortgagee. Make the seller the additional insured on the policy.
You should contact your real estate attorney for a sub to contract PDF or an agreement for the purchase and sale of real estate subject to transaction.
With that said, here is an example of a simple subject to agreement. Use this just to get an idea of what to expect:
For a comprehesive, step-by-step document, here is a downloadable subject to real estate checklist PDF. Again, speak to your mentor, or better yet, a subject to real estate attorney, for complete safety and coverage. Use a home inspector during step four if at all possible.
Subject to real estate might appear daunting initially, but with the right knowledge and approach, it's entirely manageable. Both the seller and the investor stand to gain from such transactions.
Sellers can sidestep potential financial setbacks, foreclosures, or severe credit impacts while also potentially securing an expedited sale, sometimes even with immediate cash returns.
On the flip side, for investors, the allure of subject to real estate lies in its convenience: no need for rigorous credit evaluations, minimal or zero down payments, and a swift closing process.
Ready to take your real estate investing to the next level? Getting to know the subject to real estate is just the beginning. Watch our Free Real Estate Investor Training to learn how our Ultimate Investor Program can unlock even more opportunities and strategies in the market. Don't miss out—take the next step toward maximizing your investment potential today!
*Disclosure: Real Estate Skills is not a law firm, and the information contained here does not constitute legal advice. You should consult with an attorney before making any legal conclusions. The information presented here is educational in nature. All investments involve risks, and the past performance of an investment, industry, sector, and/or market does not guarantee future returns or results. Investors are responsible for any investment decision they make. Such decisions should be based on an evaluation of their financial situation, investment objectives, risk tolerance, and liquidity needs.
