Buying house ‘subject to’ sounds like a great idea if you want to make an owner-financed deal when there is an existing loan on the property. However, buying ‘subject to’ might not be such a good idea as it seems on the first glance.
In the now-long-gone real estate practice, many existing mortgages were assumable. This meant that a buyer could buy a house even if there is still a loan on it, and he would simply become the new person who is supposed to pay that loan. This worked the best when you’ve made the owner financing deal.
However, today this agreement isn’t that easy, as most mortgages have a due-on-sale clause, which means that any remaining loan would have to be paid at the time of the sale – in other words, they are un-assumable. This is why buying ‘subject to’ sounds like a great option. But is it really?
What Does Buying ‘Subject To’ Mean?
A subject to mortgage means that there is a mortgage that is subject to an existing mortgage. This means that the seller isn’t paying off existing mortgage and instead the buyer is taking over the payments. In other words, the unpaid balance of the existing mortgage is calculated as part of the buyer’s purchase price.
How does this work? When buying ‘subject to’, the buyer – usually the investor – evaluates the property, including the possible repair estimates, and makes an offer. When the buyer and the seller make the deal, closing of the house is deeded over to the buyer’s name, but the mortgage remains on the seller when it comes to the paperwork. Then, when the buyer makes the payments, he pays for the mortgage as well. This saves the house from foreclosure and saves the seller’s credit. This sounds complicated, but many homeowners decide to make this option because they like the idea of not only saving their credits record, but also building continuous credit by having the buyer pay their loan.
So, why would a buyer risk purchasing a property this way? Because it reduces the overall home cost. There are no closing costs, commissions, origination fees and others. This also tends to work for many real estate investors, who can profit more when buying property by this method. If you are just a homebuyer, then you might want to take over the seller’s existing interest rate. For example, if the interest rates at the moment are 8%, and the owner has a mortgage with a 6% interest rate, then that 2% difference can make a big difference in monthly payments. This is also a good option for potential buyers who can’t qualify for a traditional loan, as banks don’t have to approve your finances before making a purchase.
Is This Legal?
Buying ‘subject to’ existing mortgage is completely legal – as long as it happens once. You can’t sell subject-to if you have already purchased subject-to. However, if the payments aren’t made on time, you will end up in trouble. This is why the bank has the Due-on-Sale clause.
The Due-on-Sale clause means that the lender can call the entire loan due once the sale has been made. As the previous owner hasn’t paid out the full loan, the bank can call the loan due and demand the whole amount. However, this clause is rarely called and you most likely won’t ran across anyone who had the trouble with it – at least not if they’ve made the payments on time. This is the main reason why buying ‘subject to’ is risky. If the buyer is late on the payments, the bank has to protect itself as it has the rights to demand payments – and according to the papers, the seller is the one responsible for them and it’ll be the seller’s credit report which is damaged by this.
Types of ‘Subject To’ Deals
Buying ‘subject to’ doesn’t actually have to involve owner financing, but it’s recommended that it does. Depending on the mortgage, there are three types of options when it comes to buying ‘subject to’.
A straight subject-to cash-to-loan option is the most common one, and it means that the buyer pays the difference between the purchase price and the existing mortgage balance in cash when buying the property.
A straight subject-to with seller carryback is usually shaped as a second mortgage. In other words, the buyer agrees to make one payment to the seller’s lender and one as an interest rate to the seller.
Wrap-around subject-to gives the seller the possibility to make money on the existing mortgage balance. This happens if the interest rate of the existing mortgage is lower than the current interest rate. The buyer still gives the seller the mortgage payments, but the seller keeps the difference in interest rates. This can be the way to complete the purchase of the house without additional payments.
Why Is Buying ‘Subject To’ Risky?
Apart from the Due-on-Sale clause, there are many other reasons why buying ‘subject to’ can be risky – for both sides. This is why before making the sale the seller should prepare all the paperwork, and the seller must heed title encumbrances.
One of the problems that may happen is that the lien is higher than the home value. This poses a problem for the buyer, as they would be purchasing a home in full price, and also paying even more to cover the debt. That is usually not considered to be a smart move.
Another problem comes if the original homeowner dies. This will make the bank start the Due-on-Sale, which is again not looking too good for the buyer. All in all, as long as the debt isn’t fully paid, the buyer is in danger of suddenly having to pay the large amount of money.
And once the debt is paid, the person who will be relieved is not the buyer, but rather the seller, as the buyer had relieved them of their mortgage. In short, everything about buying ‘subject to’ is working in the seller’s favor – unless the buyer stops paying mortgages in time, but even then the buyer can lose the property he or she paid for.
Can You Sell Your House to Get Rid of Mortgage?
If you want to sell your house to get rid of mortgage, but don’t think that making a ‘subject to’ sale is safe enough for you, don’t worry. You can always sell your house to a direct buyer, such as Sparks Property Investors LLC. We buy houses directly from local homeowners and can help you close the sale in only couple of days. And we will take on your mortgage payments together with your house,