May 16, 2016
By David Saba
Real estate investors have various means of purchasing property with the most popular being buying in cash, contract or lease option. Investors, however, have creatively devised other ways of buying homes in the recent past. The one way that has attracted a lot of attention is buying property "subject to". Buying a home or real estate "subject to" refers to the property being subject to an existing mortgage or financing that is already in place on the property. Most homeowners agree sell their home "subject to" when they are financially strapped and need a relief from the debt. Other common reasons would be divorces, transfers, losing a job or need to purchase a new home.
Although many investors are not sure whether this method is legal or not, it's still one of the fastest, safest and arguably most lucrative means of investing in real estate. It is also a genuine way of purchasing real estate property as it involves a pact between the homeowner and the buyer and terms are vividly defined. This transaction is private and does not include acquiring consent from the financier or mortgage company. The deal, however, does not mean any of the parties abscond settling the mortgage as the lien still exists, and the terms and conditions of the loan apply. The seller of the property (the previous owner whose name is on the mortgage in this case) is still legally obligated to pay back their loan until it is fully settled even though the new owner acquires immediate ownership of the property.
Take for example; Chris is a homeowner in an attractive neighborhood where real estate investors would like to purchase a property. This home carries a mortgage. Unfortunately, Chris loses his job and has no means to keep up paying his mortgage. Coincidentally, he gets connected to Jolene who is a real estate investor. He sells the home to Jolene subject to the mortgage. The title of the home is deeded to Jolene, and she takes responsibility for the loan balance. She defaults in the mortgage repayment for three months, and the mortgage company decides to make a foreclosure sale so as to recover their funds. Since Chris sold his property subject to the mortgage, he is fully liable or responsible for the misfortune caused by proceeds of the foreclosed sale not meeting the obligations as required. The bad credit record goes to Chris and not Jolene.
Most mortgages contain a due on sale clause (also known as acceleration or alienation clause) that has been a federal issue over the years. This is vital when the homeowner wants to sell the property and has not settled the loan yet. The primary use of this clause is to bar the owner of the home from disposing the property or selling subject to an existing loan.
The "due on sale" clause states that the lender has the right to claim the arrears of the loan when the property changes possession or is sold to an investor. It further declares that lenders have the right to call the loan due or foreclose if the borrower violates any of the terms and conditions stipulated in their agreement such as transferring deed without paying back the original loan. Usually, this is just a contractual right and not a law. The lender can opt to call the loan due but is not necessarily required to do so, since the foreclosure or holding a non-performing asset has adverse effects to them as well.
The due on sale clause makes most investors shy away from buying property using the ''subject to'' process since they can lose property if the existing lender asks for the money. The clause is not certain about the federal law prohibiting lenders from demanding instant full payment of loans if they are not aware or notified of the "subject to" deal so as to approve of it especially if the borrower is not a natural being.
Consider this scenario; Mark is a homeowner who has financing in place with his home as collateral for the loan. He opts to sell this home on a land contract so as to bypass the due on sale clause. The lender then demands full payment of his loan or otherwise it will be on a verge of being foreclosed. The new owner or investor then risks losing the property. Calling the note due is a lose-lose situation as the lender falls in "bad books" of the federal law as they will have a bad debt due to a non-performing loan. It comes with punishment for the lender or the mortgage company as they will be barred from loaning property worth eight times what they have in bad debts.
The buyer or new owner of the property ought to take responsibility for the loan and pay it off or risk losing the property to foreclosure. This means the seller or the initial homeowner's burden of making payments is offloaded. However, if at all there will be a foreclosure then it adversely affects the seller/original homeowner's credit record as they are the ones legally obligated to make payments. In a situation where the debt is foreclosed, and the bank sells property so as to recover their money, failure to recover their funds will lead to the making of a deficiency judgement against the new owner and the old owner who is the borrower of the loan will be held accountable for the balance of the note which remains unpaid. In cases where the initial homeowner or borrower has been released by the assumer, then only the new owner is liable.
A homeowner can reap significant benefits by selling their home "subject to" if they have an incredible home in a good neighborhood through leasing option. This method of selling property is also beneficial for divorced individuals since their income is split into half. The "subject to" deal can come along with some other money transactions that can bail the seller out of a financial burden, especially with the current credit crunch. This way they can start over. If the seller wants to move to another house, they do not have to wait for an affluent buyer or someone with a good credit to buy their home. They can deed the home in an easy, profitable and convenient way. Homeowners who just lost their jobs can escape the pressure to pay off their debt and get relief by selling the home "subject to".
Buying a home "subject to" is a perfect strategy to achieve financial freedom especially for someone who has a poor credit record and is in dire need of purchasing a home or land. It is also advantageous as buyers have control of the property and can make money out of it; first buyers in most instances are paid by the sellers to lure them into buying the property. The seller also grants a buyer the property's deed and a non-refundable option to consider. After they purchase the property, they get to enjoy tax benefits like interest deductions or depreciation. There are also benefits in terms of the spread between the lease payment received and the mortgage payment. When the new owner sells the property, they gain from the profits received as a result of the difference between the amount they are selling it for and the amount they paid for the home.
This method of purchasing homes is arguably legal as evident in lines 203 and 503 of HUD1. Apparently, none of the state or federal laws existent considers it a crime to circumvent a "due on sale" clause. This means that transfer of titles that are secured by the "due on sale" clause on the mortgage is not illegal. It's allowed if only the sellers agree with the investors on "Subject to" and the lenders are delighted to have another entity that plays a role in settling their loan.
Purchasing homes "subject to" mortgages also has its limitations. One of the potential pitfalls of this method of buying property is the breach of contract by the seller. Assume Lawrence is a buyer who lease options a home sold to him by Mark through a subject to arrangement. Mark then decides not to sell the house after all. This will involve legal action against Mark for breach of contract, and this could consume a lot of time and funds. Lawrence might as well lose the tenant (if any) who was going to take part in refinancing the home and might risk being sued as well.
Additionally, the existence of malicious sellers who manipulate devious advocates at a later date to claim back their property remains a challenge. These corrupt advocates agree to go to court with relentless efforts to prove that the investor illegally acquired or stole property from the unsuspecting sellers. Most investors have been accused and have suffered in the hands of these unscrupulous dealers oblivion of what to do. They have ended up using a lot of funds just to prove themselves innocent in the court of law even though most are found innocent of the charges against them.
Investors are advised to be very careful when purchasing homes "subject to". They should not indulge in convincing a seller they know nothing about. Instead, they should focus on sellers that are thrilled with the idea that it will relief them from the debt and are interested in making the deal work. Buyers should also exercise their ethical responsibilities by paying transfer taxes (if any) to the state as required. They should ensure they do not conceal any part of the transactions that take place when buying homes subject to and oversee regular payments of the mortgage.
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