In the world of creative real estate investing, buying a property “subject to” the existing financing can be a powerful strategy. If you’re new to this concept or looking to expand your knowledge, you’re in the right place.
Buying a house “subject to” means purchasing the property while the original mortgage remains in the seller’s name. This allows the buyer to take over the payments without assuming the loan. Simple, right? Let’s break it down further.
What is “Subject To” and How Does It Work?
Imagine Ryan has a house for sale, but he’s facing foreclosure. As an investor, you agree to buy the house from Ryan. The deed is transferred to you, making you the new owner. However, you leave the mortgage in Ryan’s name and take over the payments. This transaction triggers the “Due on Sale Clause,” a common clause in mortgages from lenders like Bank of America or Wells Fargo.
The Due on Sale Clause Explained
This clause states that when the property is sold or an interest in it is transferred, the lender has the option to demand the full repayment of the mortgage. This clause may be buried in the fine print, but it’s a critical part of the deed of trust.
Is Buying “Subject To” Legal?
Yes, it’s absolutely legal to buy a house “subject to.” It’s important to understand that this process triggers the due on sale clause; it doesn’t violate it. The clause gives the bank the option, not the obligation, to call the remainder of the mortgage due.
Handling the Due on Sale Clause
When dealing with the due on sale clause, disclosure is key. Proper communication with the seller and making sure they understand the clause can save you from future headaches. Historically, lenders rarely call the due on sale clause unless payments aren’t being made.
Insurance Management
One common mistake is managing insurance incorrectly, which can lead to the due on sale clause being triggered. When you buy a property “subject to,” it’s crucial to update the insurance policy:
- Name the new owner as the “Named Insured.”
- List the seller as the “Also Insured.”
- Include the lender as the “Primary Mortgagee.”
If you sell the property with an owner finance wraparound mortgage, you must adjust the insurance accordingly to reflect both the primary and secondary mortgagees correctly.
What If the Due on Sale Clause is Called?
In the unlikely event that the due on sale clause is called, several options can help:
- Pay Off the Loan: Use your savings or find a private lender to pay off the mortgage.
- Refinance the Loan: Either you or the original seller can refinance to satisfy the lender.
- Transfer Back Temporarily: Transfer the property back to the seller’s name momentarily and then into a trust before reassigning it.
It’s essential to keep proper documentation and work with an experienced attorney, insurance agent, and lender to navigate these solutions effectively.
Example of Real-Life Scenarios
- Small Banks Transition: When smaller banks are acquired by larger ones, the new entity might review existing loans and call the due on sale clauses.
- Mortgage Sabotage: Sometimes, spiteful actions from individuals (like a vengeful ex-spouse) can lead to the due on sale clause being enforced.
Proper disclosure to your seller and buyer is vital. Both parties should understand the due on sale clause and the potential outcomes if it’s triggered.
Protecting Yourself with Trusts
While some investors use trusts to hold properties and attempt to avoid triggering the due on sale clause, it’s not a foolproof strategy. Although it adds a level of anonymity, it’s critical to understand the rules. Transferring a property into a trust for investment purposes isn’t the same as for estate planning, and the bank may still enforce the due on sale clause if they uncover the true nature of the transfer.
Summary
Purchasing a property “subject to” the existing financing is a potent strategy for real estate investors seeking creative ways to acquire properties without assuming the original mortgage. While this method offers significant advantages, understanding and managing the due on sale clause is essential to avoid potential pitfalls.
Properly handling insurance, maintaining open communication with all parties involved, and being prepared with backup plans if the due on sale clause is called are critical components of success in these transactions.
By staying informed and working with experienced professionals, investors can effectively leverage “subject to” deals to build their real estate portfolios and navigate the complexities of the process.
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