We know that traditional real estate investing is mainly about buying low, selling high, and making profits from that difference. This conventional approach to investing typically requires financing a property using traditional mortgages or private money lenders. The whole process usually takes an average of a month to six months depending on the situation. However, there are some scenarios where these conventional options can’t get the job done. If this is something you’re dealing with, there are creative financing options that you can incorporate to secure a profitable deal. One of these creative methods is known as a subject to real estate.
This might be your first time haring of this investment property financing method, but it’s actually been around for some time. This method of creative financing involves working out an agreement that is fair to both the property seller and the buyer without using banks or mortgage brokers. It’s an effective method if you’re just getting started in real estate investing or want to buy your first investment property with little to no money down. This can also be a great strategy for experienced investors as well. Let’s go over what you need to know about the subject to real estate investing strategy, its benefits, and how it works.
Related: Real Estate Investment Financing: 7 Ways That Work for Beginners
What is a Subject to Real Estate Deal?
Let’s first explain what a “subject to” is. Buying a subject to property means buying a home subject to the existing mortgage that is already in place. In other words, the homeowner is not paying off the existing mortgage and the buyer is taking over the mortgage payments. However, this doesn’t mean the buyer will assume the loan. Instead, the existing loan stays in the name of the property seller, but the buyer takes the title of the real estate property and makes payments on the existing mortgage. The unpaid balance of the existing mortgage is calculated as part of the purchase price. There are three types of subject to real estate deals:
1) A straight subject to cash-to-loan
This is the simplest and most common type of subject to. It’s when buyers pay the difference between the purchase price and the seller’s existing loan balance in cash. For example, if the existing loan balance is $150,000 and the sales price is $200,000, the buyer must give the seller $50,000 in cash.
2) A straight subject to with seller carryback
Also known as seller or owner financing, this is commonly found in the form of a second mortgage. Say the sales price is $200,000, the existing loan balance is $150,000, and the buyer is making a down payment of $20,000. In this case, the seller would carry the remaining balance of $30,000 at a separate interest rate and terms negotiated between the parties. The buyer makes one payment to the lender and a separate payment at a different rate to the seller.
3) Wrap-around subject to
Here, the seller charges money on the existing balance. Say the existing mortgage carries a 5% interest rate. If the sales price is $200,000 and the buyer makes a down payment of $20,000, the seller’s carryback would be $180,000. The seller can carryback a new mortgage at a rate of 6% and wrap it around the existing mortgage. From there, the buyer would pay 6% on the $180,000 to the seller. Then, the seller makes their payment to the existing mortgage and gets to keep the 1% difference.
Advantages of Subject to Real Estate
There are several benefits to subject to investing, not just for you as a real estate investor, but for the property seller and their lenders! First, this method is great for buying an investment property for buyers with insufficient credit (can’t qualify for a loan) or little cash. Hence, subject to real estate makes your leverage extremely high since you place a small amount of cash for a larger return. Moreover, leaving out usual suspects like title companies, agents, and loan officers makes the real estate transaction more cost-efficient for both parties.
When an agreement is made between the property seller and investor, the equity left in the home is an instant profit for the investor. In addition, as a buyer, you’ll have instant ownership of the house. Some investors will rent out the property while under contract to create profit from the difference between the agreed mortgage payment and rent earned. Many will take ownership of the house for a short period of time, pay the existing mortgage, rehab the property, and resell it for an immediate profit.
As for motivated sellers, there are a number of benefits that attract them to agree to this method. Some are facing foreclosure, sickness, job change, or divorce and have an immediate need for cash. Subject to real estate can provide an instant solution to their urgent problem. Also, because the buyer is responsible for making mortgage payments on time, this can improve the seller’s credit score. In addition, they will not have to pay closing costs, fees, or make repairs. A subject to mortgage will also benefit lenders as the loan will be made current, payment will be made on time, and they’ll avoid a foreclosure.
How Do You Find Subject to Real Estate Deals
In order to guarantee that a subject to real estate deal works, investors need to make sure they’re making this offer to the right property seller or homeowner. To find the best deals, look for owners who are behind on payments or are already in foreclosure. Owners of distressed real estate property who can’t afford to make the repairs are also motivated sellers, making them the best candidates for subject to purchases. Explain to them that you’re a cash buyer interested in buying their property with a subject to real estate contract. Depending on their financial situation, it’s likely that they’ll agree.
You can find motivated sellers using Mashvisor. Mashvisor offers several real estate investment tools, one of which is the Property Marketplace. This tool gives you access to a huge database of distressed properties anywhere in the US housing market 2020. This includes foreclosed homes, short-sales, auctioned homes, and bank-owned homes. You can use filters to search through thousands of listings and narrow down listings to match your criteria. Our filters include budget, location, property type, number of bedrooms and bathrooms, and your desired return on investment in terms of cash on cash return and cap rate.
Mashvisor Property Marketplace
The Property Marketplace also allows you to analyze these distressed properties for sale and gives you access to homeowner data. This data includes their full address, full name, age, marital status, education, occupation, net worth, and more. Instead of chasing after those who aren’t likely to sell, this data allows you to identify the best off market properties to approach with a subject to real estate contract like a pro! For more details, read this complete Mashvisor Property Marketplace Guide for Real Estate Investors.
Risks of Subject to Real Estate Investing
As you can see, the subject to strategy is one of the easiest and cheapest ways to acquire a property. However, contrary to what some will tell you, it is not without risk. While the investor owns the house and equity in the house, the property is still legally the seller’s liability. Meaning, they still own financial commitments to the loan taken subject to. So, if they file for bankruptcy, the property could be seized or foreclosed.
Furthermore, agreeing to make payments on someone’s mortgage is a huge responsibility. If you fail to make a payment, you won’t be held liable by the lender. However, the credit score of the seller could suffer because he/she is still tied into the mortgage agreement. In other words, if the bank has to foreclose the property, your credit as the buyers would not be hurt. Nonetheless, you will lose all your equity in the property if this happened. As a result, anyone using the subject to real estate strategy should approach the loan as if he/she had personally signed the mortgage.
Finally, the most asked question about this method is “what about the due on sale clause?” Most mortgage lenders write a due on sale clause into the loan document. This prevents someone else from assuming the mortgage and calls the loan due if the title changes hands. Meaning, it invokes immediate payment on the rest of the mortgage. In the vast majority of cases, however, lenders chose not to do so – especially if payments are made on time – because they want payments, not foreclosures. Real estate investors can also get around this clause by creating a contract with the seller that grants the deed, but not the existing mortgage liability.
3 Tips for Real Estate Investors
1) Hire a real estate attorney: A common question that investors ask before buying a subject to investment property is “is it legal?” The answer is yes – but laws of different states tend to vary regarding how they deal with these transactions. Subject to real estate contracts are also state-specific. So, it’s crucial to have a trusted real estate attorney who knows state laws and consult you throughout the process.
2) Research the loan terms: It’s important to do your due diligence as an investor before buying an investment property. When following this strategy, your due diligence includes studying the terms of the loan before agreeing to make its payments. Look for items or clauses such as prepay penalties. Check whether the loan is adjustable-rate or fixed, if the loan has been modified, and if insurance and taxes are included in the monthly payment.
3) Analyze the investment property: Just like before buying any property, running an investment property analysis is a must. For example, if you plan to renovate the house and sell it, you should estimate your total cash investment and the after repair value (ARV) to see if it’s worth investing in. Likewise, if you plan to rent out the property, you need to estimate the potential rental income and expenses to see if it’s going to be a cash flow property. This is something Mashvisor can help you with. Learn more about our product here.
The Bottom Line
To sum up, a subject to real estate is a creative method of financing that every savvy investor should have in his/her toolbox. It’s a great way to start a real estate investing business with little money. And there’s nothing illegal or unethical about it. You can get a leg up on the competition in the current housing market as you’ll be able to acquire property regardless of whether it’s a seller’s market or a buyer’s market. To start looking for motivated sellers anywhere in the US and analyzing their properties to see whether they make for good real estate investments, start your 7-day free trial with Mashvisor.