Subject To Real Estate: An Investor’s Guide

Written by Paul Esajian

Your real estate investment career might get stalled if you have poor credit. Even if you have the cash to purchase a home or sufficient income to handle a mortgage loan, poor credit could prevent you from securing a mortgage loan.

Many investors turn to subject to real estate deals to purchase properties without securing a mortgage. Subject to real estate is also a practical option for those who need to buy/sell a home quickly and cost-effectively.

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What Does Subject To Mean in Real Estate?

In real estate, subject to means that you’re buying a home that’s subject to an existing mortgage.
Under normal circumstances, what happens when a homeowner sells a property in which the mortgage hasn’t been fully paid off?

Most often, the proceeds of the sale are used to pay off the remaining mortgage, and the seller pockets the rest. Or, the buyer may take over the remaining mortgage, a process called “mortgage assumption.”
Subject to is a middle-ground between both options. Under a subject to, the buyer agrees to make payments to the seller’s mortgage company until the mortgage is fully paid off. The mortgage remains in the original owner’s name, but the buyer pays it off.

Sometimes, the buyer may be required to pay off the remaining mortgage balance within a short period, but the buyer may also make recurring payments over a longer period.

Key items to note:

• There’s often no “official” agreement between the buyer and seller
• The buyer (in some cases) has no legal obligation to make the mortgage payments
• However, the home could fall into foreclosure if the buyer fails to make payments

At first glance, it appears that the seller takes on more risk since the buyer has no legal obligation to make the mortgage payments. But even though the buyer is not assuming the mortgage, the buyer is still taking the property title. If the buyer stops making payments, the house will fall into foreclosure, and the buyer will lose it.

Usually, that’s plenty of motivation for a buyer to uphold their end of the bargain.

Types of Subject To Real Estate Deals

There are three types of subject to real estate deals:

• Cash-to-loan subject to
• Seller carry back subject to
• Wrap-around subject to

Let’s compare each one.

Cash-to-Loan Subject To

A cash-to-loan subject to is the most simple and common type of subject to. When you buy a home from a seller, you’ll pay the existing loan balance in cash.

For example, if you’re buying a home for $300,000, and the existing mortgage balance is $250,000, then you’d pay the seller $50,000 in cash, in addition to the sales price.

As you can see, the buyer isn’t assuming the mortgage. The buyer is just paying forward an extra sum so the seller can pay the remaining balance.

When you hear people mention a subject to, they’re most often referring to a cash-to-loan transaction.

Seller Carryback Subject To

Seller carryback is also known as “seller financing” or “owner financing.” The transaction is similar to a second mortgage.

A seller carryback may be a necessary option if a lender won’t offer the buyer the total amount of financing needed to buy the property.

For example, let’s assume that a property is selling for $300,000. The buyer can only secure financing for $250,000, so they receive a “loan” from the seller for the remaining $50,000. The buyer makes payments to the lender on the $250,000 borrowed and makes payments to the seller for the $50,000 borrowed.

The seller doesn’t actually give the buyer any money—they just allow the buyer to pay installments over a short period. In the example above, the buyer would be given a short amount of time to pay the seller carryback of $50,000.

The down payment, interest rate, and terms can be negotiated between the buyer and seller. The buyer must often pay off the purchase price in 5 years or less and is typically required to make a down payment anywhere between 5% and 25% (the seller stipulates the percentage).

Wrap-Around Subject To

A wrap-around subject to is similar to a seller carryback, but the interest rate that the buyer pays is based on the interest rate for the original mortgage loan.

Because the seller must pay interest on the original mortgage, they’ll require the buyer to pay a proportional interest rate that covers it.

If a seller’s mortgage interest is 5%, they might require the buyer to pay 7% interest on the carryback. Ideally, the seller would make enough money to compensate for the interest on the original mortgage.

Benefits of Subject To Real Estate

Subject to real estate has several significant benefits. Let’s start with the benefits for buyers:

• Easier to Buy a Property: Subject to real estate is a suitable method for investors who have insufficient credit to finance a home. You can buy a property through subject to even if you wouldn’t normally qualify for financing. You may also get a better interest rate than a standard mortgage.
• Cost-Effective: Since there are no banks, title companies, agents, or loan officers involved in the transaction, subject to deals usually come with fewer up-front costs and closing costs. Closing costs alone can price you out of a home that you might otherwise afford, so that makes subject to real estate worth considering if a property is just out of your price range.
• Faster Equity/Income: When you purchase a subject to property, you’ll gain equity in the property very quickly since some of the mortgage has already been paid. Subject to transactions also close much faster than standard mortgage transactions, so they’re more ideal for house flipping.

Now let’s cover the benefits of subject to real estate for sellers:

• Saving Grace: Unfortunately, some homeowners are facing foreclosure, or they have a major life event—like a divorce—that requires them to dispose of a property to get cash quickly. A subject to real estate deal can be a necessary solution for these homeowners.
• No Repairs Needed: Similarly, subject-to sales often accept the property in as-is condition. This can be highly beneficial if the homeowner needs to sell quickly or does not have the ability to pay for repairs at the time of the sale.
• Quick Sales: A real estate investor might want to quickly sell a property so they can finance a new, more profitable investment. A subject to transaction can help the investor quickly and affordably dispose of a property.
• Avoid Closing costs: In many subject-to sales, sellers are not responsible for closing costs. This can help them reduce costs associated with selling, which can eliminate a lot of stress during the transaction process.

Risks of Subject To Real Estate

You need to account for some significant risks before you participate in a subject to transaction.

First, let’s cover the risks for buyers:

• Foreclosure: When you’re buying a property without using a standard mortgage, it’s easy to convince yourself that you’re financially prepared to buy the property even when you’re not. Standard mortgages can be effective in weeding out those who don’t have the money to handle homeownership’s financial obligations. Even if you’ve secured financing for most of the sales price—in the case of a seller carryback—some homebuyers might underestimate the difficulty of making two different payments to a seller and a lender. Subject to real estate is most efficient for investors who have multiple streams of income and have plenty of cash to handle the multitude of payments.
• Loan Acceleration: Under some subject to real estate agreements, the lender reserves the right to accelerate the loan and mandate a full payoff earlier than you intended. That puts you at a major disadvantage.
• Insurance: It’s much more difficult to insure properties acquired through subject to transactions. That’s something to think about if you plan on holding the property for a long period.

Now let’s cover the risks for sellers. The seller undoubtedly faces the most risk in a subject to transaction.

• Liability: Although the buyer owns the home and acquires equity in the property, the seller is still liable for the mortgage. If the buyer doesn’t make the mortgage payments, you could face liability if foreclosure doesn’t cover the outstanding mortgage balance. Your credit score would be significantly damaged. It’s not enough to sign an agreement with the buyer—you need to find a buyer whom you’re confident will make the agreed-upon mortgage payments.
• “Due on Sale” Clause: Some mortgages have a “due on sale” clause, which mandates that you pay the remaining mortgage when you sell the property. Lenders often don’t enforce this clause because they’d rather receive steady mortgage payments than pursue foreclosure—but some lenders might. If you’re forced to pay the outstanding mortgage when you sell, then you won’t earn any interest on the buyer’s mortgage payments. The sale will be far less profitable.

Why Would A Seller Want A Subject To Deal?

A seller will usually agree to a subject to deal when they are in financial trouble. One example of this is when they are facing foreclosure due to not being able to afford their mortgage. Since subject to deals are often quick get started, the seller will be relieved of their financial burdens faster than many other solutions. They also have a chance to improve their credit score, as the buyer is actually paying for the mortgage while it is in the seller’s name. Finally, a seller will save money by not paying closing costs as they aren’t selling their home through a realtor or broker.

Subject To vs. Loan Assumption

There’s a major difference between a subject to transaction and a loan assumption.

In a subject to real estate transaction, neither the buyer nor the seller informs the lender that the seller has sold the property. The buyer does not get the lender’s permission to take over the mortgage payments; lenders may enforce a “due on sale” clause if they discover a property has been transferred.
Many lenders don’t mind that a property has been transferred, so long as somebody makes the mortgage payments. But all lenders are different, and some real estate investors don’t want to take any chances. Subject to real estate deals, while not illegal, are meant to be conducted “under the radar.”

On the contrary, loan assumption is when the buyer formally takes over the mortgage from the seller. The buyer must qualify for the loan, and once the buyer is qualified, the seller is removed from the mortgage and no longer held liable.

The buyer is usually charged a “loan assumption fee.” It’s not an expensive fee, but it’s just another expense that subject to investors like to avoid.

How To Find Subject To Real Estate Deals

How exactly do you find subject to deals?

You can find subject to deals by using online real estate listing platforms and searching for specific terms. Some of the best deals are properties that are already in foreclosure, or properties that are behind on payments. Investors can target distressed or vacant-looking properties as they search for potential listings. Owners who cannot make necessary repairs may be open to a subject to deal.

Another way to find these properties is to execute a direct mail campaign, targeting potentially motivated sellers. Create multiple mailers with your contact information and follow up on possible leads to make these deals happen. You may also find success by utilizing your existing real estate network. Ask around for potential foreclosures or sellers in need of a quick sale. These could lead to a subject to deal.

When To Offer Subject To Deals

If you’re a buyer, you can offer a subject to deal if the seller:

• Needs quick debt relief
• Is facing foreclosure
• Has to relocate and needs to sell the home quickly

These sellers are more likely to agree to a subject to deal. But you can offer a subject to to any seller if:

• The property has existing equity
• The property is a multifamily home that’s already generating a cashflow
• The property is a fix-and-flip, but the seller can’t afford repairs

If you’re a seller, you can offer a subject to deal to any buyer who:

• Can’t secure financing due to low credit
• Doesn’t have the cash for a sufficient down payment
• Is an experienced investor with a diverse real estate portfolio

How To Present Subject To

When you’ve identified a buyer or seller with whom to offer a subject to, you need to reach out to them and make a proposal. Keep in mind that every buyer/seller has different motivations, and you want to make sure that your proposal meets their needs and yours.

If you’re making a proposal to a seller, present the subject to as just one of many different options. Explain how the speed and cost-effectiveness of a subject to may be advantageous to the seller.

If you’re making a proposal to a buyer, explain your situation and emphasize how the buyer can benefit from the transaction’s speed and cost-effectiveness. Even if you’re in a precarious financial situation, don’t let the buyer set the terms and rates for the transaction. As the seller, you still have the upper hand in all negotiations.

Due Diligence

Before you take part in a subject to transaction, make sure you do your due diligence and:

• Research State Laws: Some states may have regulations concerning subject to deals and owner financing.
• Consider Loan Terms: If you’re a buyer, make sure you know whether the loan is fixed-rate or adjustable (adjustable terms can throw a wrench into your financial planning). Also make sure you know whether insurance or taxes are included in the monthly payment.
• Past Balances: The seller may not be up-to-date on utility payments. Make sure you know which past balances you’ll assume if you take over the property.
• Buyer Vetting: If you’re a seller, you need to make sure that your prospective buyer has the income to make the mortgage payments on time. Ask for proof of income, or ask to see the investor’s real estate portfolio. These aren’t unreasonable requests.
• Decide On An Offer: Based on the condition of the property and the seller’s position, you can decide on the right offer and exit strategy. In some cases this will require your own funds, but in others you may find yourself getting paid to take the house off their hands.

This kind of preliminary research is the best way to protect yourself in a subject to real estate deal and ensure that you’re partnering with the right person.

[ Thinking about investing in real estate? Register to attend a FREE online real estate class and learn how to get started investing in real estate. ]

Tips for Subject To Real Estate Investing

Here are a couple of important tips for investors who are considering a subject to deal:

• Hire a Real Estate Attorney: It’s vital that you hire a real estate attorney to oversee the subject to deal. The attorney will help create a legally binding contract between you and the buyer/seller so that you’re protected if things don’t go smoothly. They can also help you navigate “due on sale” clauses that might be featured on the mortgage loan.
• Plan Your Investment Strategy: If you’re pursuing a subject to deal for real estate investment, make sure that it fits your overall investment strategy. A subject to is generally a high-risk investment, so be sure to counterbalance it with low-risk investments, like rental properties or property management income.
• Research the Loan Terms: You should always perform your due diligence before buying any type of property. In this scenario, study the loan terms before you make any agreements. There may be hidden items and clauses to watch out for, such as prepay penalties. Also make sure to understand whether the interest rate is adjustable or fixed, and whether or not insurance and taxes are already included in the monthly payment.
• Analyze the Investment Property: Run a thorough investment property analysis to make sure you’re making a worthy investment, and that your exit strategy is sound. For example, conduct a rental market analysis to estimate your potential rental income or run neighborhood comps to see if your after repair value is worthwhile.

Summary

A subject to real estate deal is when you buy or sell a property with an existing mortgage. Under a subject to deal, the buyer takes over the property, but the seller retains the mortgage. The buyer makes mortgage payments for the seller, and the lender is not informed that the property has been transferred. For buyers, subject to is an excellent way to buy a property when you have insufficient credit or when you want to buy a property with fewer closing costs. For sellers, subject to is a good way to quickly dispose of a property if you need immediate debt relief or if you’re facing foreclosure. Foreclosure is a major risk for buyers and sellers participating in a subject to, and it’s generally a high-risk investment. It’s highly advised that you seek an experienced real estate attorney to help you draft a subject to agreement.

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