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REAL ESTATE POWER STRATEGY
Buying Property “Subject To” The Existing
Mortgage
By Jan
Cetwinski
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Special Note: Chicago Investment
Property can be purchased multiple different ways. Cash is always a
good purchase, but subject to investing is a powerful strategy to capture
Chicago Investment property.
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Buying property Subject
To is a powerful tool that every investor should use in the appropriate
situations. Although the term is used frequently, does it refer to a
buying method, a contingency, or both? In general, the phrase “subject to”
simply refers to a condition in a contract that must be met or the
contract will be null and void. For example, a contract can be written to
include the following clause: “This contract is subject to a professional
home inspection acceptable to the Buyer.” Used in this fashion, it becomes
a contingency because the contract is dependent upon some action or
result. Unless the Buyer accepts the inspection report, the sales
transaction will not close because it was subject to an acceptable
report.
For the purpose of this
article, we will be discussing Subject To as a method for acquiring
property by taking over the payments on the existing loans(s) of the
seller. In this instance, the buyer does not actually assume the loan by
putting it into their name; they simply take over the responsibility of
making the monthly payments. The seller signs over the deed to his or her
home “subject to” the existing mortgage staying in place. The sale is
Subject To the mortgage because the debt is a lien on the property and
cannot be removed simply by transferring ownership.
When is it beneficial to
use the Subject To strategy? The best opportunities for using Subject To
for buying property relate to the seller's situation and/or the terms of
the existing mortgage. Normally, the seller's situation must involve a
sense of urgency to the sale so that the seller receives a benefit from a
quick sale, even though their loan is not paid off (and they would face
difficulty if they could not sell their house quickly). A seller who
simply lists his property to see if he can get the highest price possible,
and isn't concerned with whether it sells or not, is not the best
candidate for a Subject To purchase.
Buying a property Subject
To offers a number of benefits. The buyer is not required to initiate and
qualify for a new mortgage loan. In today's tight mortgage market, this
can certainly speed up the process and may even make the difference of
being able to complete the deal.
But even if qualifying
for a new mortgage is not an issue, Subject To is a powerful strategy.
Since the loan stays in the seller's name, it does not appear on the
buyer's credit report. Even with good credit, a buyer will quickly be
limited to the number of properties that a conventional lender is willing
to finance. With a Subject To purchase, there is no limit to the number of
properties you can buy.
CAUTION: Whenever buying
a property Subject To the existing mortgage, the buyer agrees to take on
the responsibility to make every monthly payment on a timely basis.
Although not legally liable for the mortgage debt, the buyer has
represented to the seller that the payments will be made. Therefore, the
buyer has an obligation to follow through on their commitment.
For loans that have been
in place for a number of years the buyer also gains the advantage of the
amortization on the existing mortgage. Because payments at the beginning
of a loan are primarily interest, the buyer benefits from taking over the
loan after those first years of amortization. Based on the number of years
that the loan has been in place this advantage can be substantial.
Not all the benefits fall
on the side of the buyer. The benefit to the seller is a quick sale and
close. In addition, the sale is more certain because sales in the
conventional retail market often fall through when the buyer can't qualify
for the loan. And by selling to an investor, the seller pays no Realtor
fees. In a situation where the seller has only owned the property for 2-3
years, selling it Subject To could mean the difference between bringing
money to the closing table or being able to walk away clean.
Of course, there are also
some possible drawbacks to this acquisition method. Although often
considered a tool to structure a no-money-down deal, this is not always
the case. The amount of cash necessary is dependent on the difference
between the purchase price and the existing mortgage balance. When the
mortgage was issued 3-4 years ago, the current balance will often be close
to the purchase price that you have negotiated. Therefore, this can be
structured as a no-money-down deal.
However, there are also
situations where a buyer might need to bring cash to the closing table,
perhaps even more cash than if it was purchased using a conventional
mortgage. Rather than making a 5% down payment using a conventional bank
loan, the buyer will need to pay the seller the difference between the
purchase price and the balance of the existing loan. For example, if the
purchase price is $200,000 and the existing loan balance is only $136,000,
then the buyer must pay $64,000 to compensate the seller for the full
price. In such a case, buying Subject To the mortgage may not be the best
solution. However, many times it is still the preferable structure for the
deal. If the house needs heavy rehab, it could be difficult to obtain a
conventional loan given the condition of the property. Yet buying the
property Subject To requires less cash than a full cash purchase.
If cash is required,
there are some alternatives to decrease the amount of cash required. The
seller could refinance to take out some cash, then the buyer could take
the property Subject To the new mortgage. Another option could be to
negotiate the amount of cash needed as owner financing. And of course, for
any cash needed for a purchase, private money could always be used rather
than the buyer's personal funds.
The aspect of Subject To
financing that generates the most discussion is the Due on Sale clause.
Every mortgage since 1978 contains such a clause which states something to
the effect that in the case of transfer of the property the Lender may
require immediate payment of the full amount of the mortgage. Note that
the lender may call the mortgage due. Thus, it is not an automatic action
taken on their part. As a practical matter, the bank is not likely to look
for trouble on a loan where the payments are being made on a timely basis.
Disclaimer: This section
regarding the Due on Sale clause covers a very general discussion. If you
purchase property using Subject To, you should always consult with your
attorney regarding this issue.
Even without the threat
of the Due on Sale clause, buying a property Subject To the mortgage is
primarily an acquisition strategy and may, or may not, be the best way to
continue ownership of the property.
In times of rising
interest rates, the existing loan (initiated by a homeowner) may have a
lower interest rate than you can find for a new loan (as an investor).
However, even if the interest rate is higher, the ability to buy property
without requiring you to obtain a loan in your name can offset the higher
interest. Remember too, that you are receiving the benefit of greater
amortization. Make sure to carefully review the terms of the note to
determine if the interest rate is fixed or adjustable, when the rate will
adjust, and what is the cap rate on the adjustment. Then you can determine
whether to maintain the loan during the holding period, or simply use it
to acquire the property and refinance once the property is stabilized. At
that time, qualifying for a refinance of a property will be based on the
current value of the property rather than your original purchase price.
Consider all the facts and then make the offer!
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Jan Cetwinski is a
licensed CPA and investor. She can be reached at jan@realtylinkspro.com.
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