What is a "Subject-to" Purchase and How Does it Work?
A "Subject-to" Purchase transaction occurs when you purchase a property from a homeowner without paying off the existing mortgage financing, liens and other title encumbrances. Basically, you and the distressed property owner negotiate a sales price as in a traditional purchase transaction, but in this case you don't pursue financing, and typically (but not recommended) close the deal without the help of a title company or other escrow agent.
The simple mechanics are as follows: After you and the seller agree on a price, you may have to send money to reinstate the defaulting loan, then give the seller any net cash due, based on the contract price. In exchange, the seller transfers title to you. The existing financing and lien structure of the property remains unchanged, but you are now the owner of record for the property. Since there is no financing in a "Subject-to" Purchase, you get cash by selling your interest in the property to a third party for more than their "subject-to" acquisition cost, or by selling the property to a third party in a more conventional, traditional way.
Investors also view "Subject-to" purchases as a low-risk way to "buy" equity in a property without the cost, time and credit risk of financing (i.e $6,000.00 can be used to purchase a property with $60,000.00 equity).
MATRIX RATING: Low Risk, Medium Complexity
INVESTOR LEVEL: Novice who has closed 1 or more transactions - Even though the whole transaction can be done without using escrow closing - using a title agent to check title is highly advisable.
WHAT'S REQUIRED: You might need cash to reinstate the defaulting loan if the property is in foreclosure, pay net contract proceeds to homeowners, carry property until rented or sold, etc.
WHAT'S OPTIONAL: Credit - only if you are paying reinstatements and seller payouts with equity lines or credit card cash advances. Otherwise, a Subject-to has no effect on your personal credit.
WHAT'S ADVISABLE: Know your exit strategy before you put up a lot of cash to reinstate a defaulting loan to purchase "Subject-to" - no matter how good a deal you think it is. Are you going to rehab it and sell it retail, flip it to a rehabber or hold it long term and rent it out? Have your exit strategy mapped out in detail before committing to buy "Subject-to." Since you do not have to use a title agent to close this type of transaction, the temptation will be to not use one to save some $$$. It's not worth it! Spend the small amount of money to get a formal title search so you know exactly what the encumbrances are on the property you plan to own, because once you take title, those obligations become yours.
ASSESSMENT: "Subject-to" deals are conceptually simple in that the strategy is to just buy low and rent for cash flow, sell over time with a “Lease-Purchase Option” or flip for an immediate cash profit. If a seller is willing to entertain a "subject-to" deal the buyer takes over responsibility for paying the seller's underlying mortgages, even after they no longer own the property. The seller and/or the property are typically distressed; sellers are motivated, and have sufficient equity to let their properties go for far less than the retail appraised value.
"Subject-to" deals differ from Contract Assignments and Power Flips, in that the investor-buyer actually closes the purchase (title transfer) and takes possession of the property. With Contract Assignments you make money by putting a property under contract, and then assigning those rights to another for a fee. In a Power Flip, you get control of the property as a seller’s proxy, sell the property and get paid at closing without ever going on title. With a Subject to, on the other hand, you actually take title and become the formal owner of the property.
"Subject-to" deals are usually done by cash-heavy investors who have targeted deeply distressed sellers & other distressed property owners such as people in foreclosure. In these distress situations, homeowners are generally more open to accepting the risk of leaving their financing in place when selling to another person. When properly structured, Subject-to deals can also be packaged and "flipped" for cash without actually taking title to a property.
BENEFITS: In today’s world of disappearing mortgage financing, the most obvious and important benefit offered by Subject-to is the ability to buy properties without banks. Buyer's can also acquire high equity properties far below market value and will have several liquidation options available to them. They can rent the property out for cash flow and tax advantages, they can rehab and resell it for a quick profit, flip it to a third party in “as-is” condition or sell it over time using a lease purchase option agreement. Like Wholesale deals, "Subject-to" makes sense for cash-heavy investors who need somewhere to put their cash long-term in exchange for beneficial tax write-off's, powerful leveraging of cash to buy equity, and for cash flow from rental income. It also is a great way for people to buy and hold real-estate who have cash, but not-so-good credit.
CHALLENGES: The biggest issue with "Subject-to" purchases is that if title formally transfers to someone other than the mortgagor, the bank or other financing institution has the right to foreclose the loan if they feel they are at risk. Although it is the bank's legal right (based on the standard mortgage agreement) to "call the loan," they seldom do, so long as payments get made as agreed. Properly structuring the paperwork and using the right legal instruments can avoid "due on sale" clause issues |
