You may have heard the term “subject to”, “sub to” or “creative financing” thrown around in the last few years. And for good reason.
“Subject to” or creative financing is one of the most strategic approaches to explore when considering selling your home. This is especially true if you are facing foreclosure, having a difficult time selling your home on the retail market, or want to avoid paying high capital gains taxes.
If you’re unfamiliar with the term “subject to mortgage” or the broader concept of creative finance in real estate, you’re in the right place.
We are here to equip you with understanding and comfort. This step-by-step guide will walk you through the ins and outs, will give examples, and highlight the key contracts you will want to use to protect you.
What Is Subject To Real Estate?
Buying a property “subject to” means that the buyer takes ownership of the property subject to the seller’s existing mortgage. In other words, the existing loan on the proper remains in place.
Investors, like us, purchase the property and enter into an agreement with the seller to make all remaining payments on the seller’s existing loan. The seller conveys title of the property to the investor, while the loan remains in the seller’s name. The buyer makes all of the mortgage payments and the seller is able to walk away from its obligations – whether financial or maintenance – from the property.
How Does the Seller Benefits with Subject To?
As the investor, we shoulder the responsibility of paying the existing mortgage, even though the loan remains formally under the seller’s name.
The seller benefits in several ways depending on their circumstances.
1. Avoid foreclosure and financial distress
Sellers facing foreclosure and/or who are severely delinquent in paying their mortgage payments are relieved of their mortgage obligation while avoiding the damaging effects of a foreclosure on their credit and mental health.
2. Landlords no longer deal with pesky tenants and aging property
Let’s face it. Some landlords are just sick of being landlords. Tenants are behind on rent, which makes paying the mortgage a financing strain. Not to mention the leaking refrigerator and broken air-conditioning that your tenants keep calling about. Selling a property “subject to” allows landlords to relive themselves of the ongoing maintenance and responsibility of being a landlord.
3. Avoiding a cash-out means significantly less capital gains tax
Selling your home the traditional way may lead to a large capital gains tax bill come tax season. By leaving the existing mortgage in place, and receiving payments of the equity over time, sellers avoid incurring large capital gains tax. For some, this can result in significant cost savings.
4. Sellers still get the equity in the home
As mentioned above, the equity in the property is paid out over an agreed upon duration between the buyer and seller. The buyer and seller agree upon a purchase price between the property’s fair market value and the outstanding mortgage amount.
What If the Buyer Misses a Payment?
We have agreements in place up front that automatically transfer the property back to the seller if the buyer defaults on the mortgage payments. We structure what is called a “performance deed” or “Deed in Lieu” pre-signed and held at a servicing company. If the investor defaults, the seller would inherit the property back and benefit from any and all loan payments, improvements made to the property, and appreciation that the property has seen while the investor was making payments. The seller could then sell the property again for even more money if they did not want to keep it.
How Long Does the Mortgage Stay in Place?
Everyone should expect the mortgage to stay in their name until the loan is paid off. As long as the payment is being serviced, having the mortgage in your name will only be a benefit. However, we and our partners typically refinance or sell the property after 5-7 years to extract equity, depending on market conditions.
What About the Due-On-Sale Clause?
This rarely happens. But, if the bank sees the deed has been transferred, they could request the remaining loan balance to be paid in one lump sum because they believe the property has been sold (hence the name due on sale). We have specific language in our closing documents to protect both of the seller and our investment.
Essentially, we would deed the property back to you via limited POA and resell the home again on an executory contract. The deed will be held in escrow and recorded once the loan is fully paid.
This type of sale is the same as when you purchase a vehicle on a loan. You don’t receive the title of the car you buy until the loan on the car is paid, even though you still own the car and are responsible for it. The only difference with a house, we lose the tax benefits of having the deed, but it’s well worth it to keep us both protected.
