Mortgagerateslocal.com – If you are a real estate investor, you know that finding and securing financing for your deals can be challenging. You may have to deal with high interest rates, strict lending criteria, hefty fees, and limited options. But what if there was a way to buy properties without applying for a new loan, paying closing costs, or even using your own money? Sounds too good to be true, right?
Well, not exactly. There is a creative financing strategy that can help you acquire properties with little to no money down, and it is called buying subject to a mortgage. This strategy involves taking over the existing mortgage of the seller, without assuming the loan or notifying the lender. You simply agree to make the monthly payments on behalf of the seller, and in return, you get the deed to the property.
Buying subject to a mortgage can be a great way to buy properties at a discount, leverage the seller’s existing interest rate, and avoid the hassle of applying for a new loan. However, it also comes with some risks and challenges, such as the possibility of the lender calling the loan due, the seller going into bankruptcy, or the property being underwater.
Therefore, you need to understand how this strategy works, what are the pros and cons, and how to protect yourself and the seller from any legal or financial issues. In this article, we will explain everything you need to know about buying subject to a mortgage. By the end, you will have a clear understanding of how to buy real estate subject to a mortgage.
What is a subject to mortgage and how does it work?
A subject to mortgage is a mortgage that is subject to an existing mortgage. It means that when you buy a property subject to a mortgage, you are not taking over the loan from the lender, but rather from the seller. You are buying the property subject to the existing mortgage, which remains in the seller’s name and credit report.
You simply agree to make the monthly payments on the seller’s behalf, and in exchange, you get the deed to the property. A subject to mortgage is different from a loan assumption, where you formally take over the loan from the lender, and the loan is transferred to your name and credit report.
A loan assumption requires the approval of the lender, and may involve paying fees, meeting certain qualifications, and signing a new promissory note. A subject to mortgage does not require any of these, as you are not dealing with the lender at all, but only with the seller.
A subject to mortgage is also different from a wrap-around mortgage, where you create a new loan that wraps around the existing loan. A wrap-around mortgage involves paying a higher interest rate and a higher monthly payment than the existing loan, and making the payment to the seller, who then pays the existing loan to the lender.
A subject to mortgage does not involve creating a new loan, but rather paying the same interest rate and monthly payment as the existing loan, and making the payment directly to the lender. The main advantage of buying subject to a mortgage is that it allows you to buy properties with little to no money down, as you do not have to pay any closing costs, origination fees, broker commissions, or other expenses.
You also do not have to qualify for a new loan, as you are using the seller’s existing loan. Moreover, you can benefit from the seller’s existing interest rate, which may be lower than the current market rate, and save money on your monthly payments.
However, buying subject to a mortgage also has some disadvantages, such as the risk of the lender finding out about the transaction and invoking the due on sale clause, which allows the lender to demand the full payment of the loan immediately, or foreclose on the property.
You also have to rely on the seller’s cooperation and honesty, as they remain liable for the loan, and may default on the loan, file for bankruptcy, or try to reclaim the property. Furthermore, you may have to deal with negative equity, as the property may be worth less than the loan balance, and you may not be able to refinance or sell the property.
What are the benefits and drawbacks of buying subject to a mortgage?
Buying subject to a mortgage has both benefits and drawbacks, depending on your perspective, goals, and situation. Here are some of the pros and cons of this strategy for both the buyer and the seller:
Benefits subject to a mortgage for the buyer
- You can buy properties with little to no money down, as you do not have to pay any closing costs, origination fees, broker commissions, or other expenses.
- You can leverage the seller’s existing interest rate, which may be lower than the current market rate, and save money on your monthly payments.
- You can avoid the hassle of applying for a new loan, as you do not have to qualify for the loan, provide any documentation, or deal with the lender.
- You can acquire properties that may not qualify for conventional financing, such as distressed, damaged, or vacant properties, and add value to them through repairs, renovations, or improvements.
- You can create positive cash flow by renting or selling the property for more than the monthly payment, and generate income and equity.
Drawbacks for the buyer
- You may face the risk of the lender finding out about the transaction and invoking the due on sale clause, which allows the lender to demand the full payment of the loan immediately, or foreclose on the property. This can happen if the lender notices a change in the insurance policy, the tax bill, or the payment method of the loan. You can try to avoid this risk by using a land trust, a power of attorney, or a third-party service to make the payments, but there is no guarantee that the lender will not discover the transfer of ownership.
- You have to rely on the seller’s cooperation and honesty, as they remain liable for the loan, and may default on the loan, file for bankruptcy, or try to reclaim the property. This can happen if the seller changes their mind, faces financial difficulties, or gets sued by a creditor. You can try to protect yourself by using a contract, a deed, an escrow account, or a title company, but there is no guarantee that the seller will honor their agreement.
- You may have to deal with negative equity, as the property may be worth less than the loan balance, and you may not be able to refinance or sell the property. This can happen if the market value of the property declines, the interest rate of the loan increases, or the loan term is longer than the expected holding period. You can try to mitigate this risk by buying the property at a discount, paying down the principal, or increasing the value of the property, but there is no guarantee that you will break even or make a profit.
Benefits for the seller
- You can sell your property quickly and easily, as you do not have to wait for the buyer to obtain financing, conduct inspections, or negotiate terms. You can close the deal in a matter of days or weeks, instead of months or years.
- You can avoid foreclosure, bankruptcy, or other financial troubles, as you can get rid of your monthly mortgage payment, and free up your cash flow and credit. You can also avoid the negative impact of a foreclosure or a short sale on your credit score and history.
- You can save money on taxes, fees, and commissions, as you do not have to pay any capital gains tax, transfer tax, or broker commission on the sale. You can also deduct the interest paid on the mortgage from your taxable income, until the property is transferred to the buyer.
- You can retain some control and ownership of the property, as you remain the legal owner of the property, until the loan is paid off or refinanced by the buyer. You can also have the option to buy back the property, if the buyer defaults on the loan or violates the contract.
Drawbacks for the seller
- You may face the risk of the lender finding out about the transaction and invoking the due on sale clause, which allows the lender to demand the full payment of the loan immediately, or foreclose on the property. This can happen if the lender notices a change in the insurance policy, the tax bill, or the payment method of the loan. You can try to avoid this risk by using a land trust, a power of attorney, or a third-party service to make the payments, but there is no guarantee that the lender will not discover the transfer of ownership.
- You have to rely on the buyer’s cooperation and honesty, as you remain liable for the loan, and may have to pay the loan, if the buyer fails to make the payments, files for bankruptcy, or tries to sell the property. This can happen if the buyer changes their mind, faces financial difficulties, or gets sued by a creditor. You can try to protect yourself by using a contract, a deed, an escrow account, or a title company, but there is no guarantee that the buyer will honor their agreement.
- You may have to deal with negative equity, as the property may be worth less than the loan balance, and you may not be able to refinance or sell the property. This can happen if the market value of the property declines, the interest rate of the loan increases, or the loan term is longer than the expected holding period. You can try to mitigate this risk by selling the property at a premium, receiving a down payment, or sharing the equity with the buyer, but there is no guarantee that you will break even or make a profit.
As you can see, buying subject to a mortgage is a complex and risky strategy, but it can also be a rewarding and profitable one, if done correctly and carefully. Therefore, you need to know the types of subject to mortgages and how to choose the best one for your situation.
The types of subject to mortgages
There are different types of subject to mortgages, depending on the terms and conditions of the transaction. Some of the common types are:
1. Straight subject to
This is the simplest and most common type of subject to mortgage, where you buy the property subject to the existing mortgage, and make the monthly payments to the lender. You do not have to pay any down payment, closing costs, or fees to the seller, and you get the deed to the property. This type is suitable for properties that have a low loan balance, a low interest rate, and a high market value.
2. Subject to with seller financing
This is a type of subject to mortgage, where you buy the property subject to the existing mortgage, and also get a second loan from the seller, which is secured by the property. You have to pay a down payment, interest, and principal to the seller, in addition to the monthly payments to the lender.
You get the deed to the property, but the seller retains a lien on the property, until you pay off the second loan. This type is suitable for properties that have a high loan balance, a high interest rate, and a low market value.
3. Subject to with lease option
This is a type of subject to mortgage, where you buy the property subject to the existing mortgage, and also get a lease option from the seller, which gives you the right to rent and buy the property within a certain period.
You have to pay a option fee, rent, and rent credits to the seller, in addition to the monthly payments to the lender. You do not get the deed to the property, but you have the option to buy it at a predetermined price, within a specified time frame. This type is suitable for properties that have a moderate loan balance, a moderate interest rate, and a moderate market value.
How to choose the best subject to mortgages
To choose the best type of subject to mortgage for your situation, you need to consider the following factors:
- The loan balance, interest rate, and term of the existing mortgage: You want to buy a property that has a low loan balance, a low interest rate, and a short term, as this will reduce your monthly payments, increase your equity, and allow you to refinance or sell the property sooner. If the existing mortgage has a high loan balance, a high interest rate, or a long term, you may want to negotiate with the seller for a lower price, a down payment, or a second loan, to make the deal more favorable to you.
- The market value, condition, and location of the property: You want to buy a property that has a high market value, a good condition, and a desirable location, as this will increase your potential income, appreciation, and demand. If the property has a low market value, a poor condition, or a bad location, you may want to avoid buying it, or ask for a discount, a lease option, or a repair allowance, to make the deal more profitable to you.
- The financial situation, motivation, and cooperation of the seller: You want to buy a property from a seller who has a financial problem, a strong motivation, and a high cooperation, as this will make the transaction easier, faster, and smoother. If the seller has a financial problem, such as a pending foreclosure, a bankruptcy, or a divorce, they may be more willing to sell their property subject to their mortgage, to get rid of their debt and stress. If the seller has a strong motivation, such as a relocation, a retirement, or a health issue, they may be more flexible and negotiable on the price, terms, and conditions of the sale. If the seller has a high cooperation, such as a trust, a rapport, or a referral, they may be more honest and reliable in honoring their agreement and providing you with the necessary documents and information.
What are the steps to buy a property subject to a mortgage?
Buying a property subject to a mortgage involves several steps, from finding and screening the property and the seller, to closing and managing the deal. Here are the main steps to buy a property subject to a mortgage:
- Step 1: Find and screen the property and the seller. You can find properties that are suitable for buying subject to a mortgage by using various sources, such as online listings, classified ads, direct mail, referrals, or networking. You can also look for signs of motivated sellers, such as pending foreclosure, bankruptcy, divorce, relocation, retirement, or health issues. Once you find a potential property and seller, you need to screen them by conducting due diligence, such as verifying the title, the loan, the value, the condition, and the location of the property, and checking the credit, the income, the debt, and the motivation of the seller. You also need to build rapport and trust with the seller, and explain the benefits and risks of selling subject to a mortgage.
- Step 2: Negotiate and sign the contract and the deed. Once you have screened the property and the seller, and decided to buy the property subject to a mortgage, you need to negotiate and sign the contract and the deed with the seller. The contract is a legal document that outlines the terms and conditions of the sale, such as the price, the closing date, the contingencies, and the responsibilities of each party. The deed is a legal document that transfers the ownership of the property from the seller to the buyer. You need to make sure that the contract and the deed are clear, accurate, and enforceable, and that they include a clause that states that the sale is subject to the existing mortgage. You also need to make sure that the seller signs the contract and the deed in front of a notary public, and that you record the deed with the county recorder’s office.
- Step 3: Close the deal and take over the payments. Once you have signed the contract and the deed, you need to close the deal and take over the payments of the existing mortgage. You need to pay any fees, taxes, or prorations that are required at closing, and obtain the keys, the insurance policy, the tax bill, and the payment coupon of the loan from the seller. You also need to change the mailing address and the contact information of the loan with the lender, and start making the monthly payments on behalf of the seller. You need to keep track of the payments, the balance, and the interest rate of the loan, and make sure that you pay on time and in full every month.
- Step 4: Manage the property and the loan. Once you have closed the deal and taken over the payments, you need to manage the property and the loan. You need to maintain, repair, or improve the property, and rent or sell it for a profit. You also need to communicate and cooperate with the seller, and keep them updated on the status of the property and the loan. You also need to monitor the market conditions, the property value, and the loan terms, and decide whether to refinance or sell the property, or to pay off or assume the loan.
Conclusion
Buying subject to a mortgage is a creative financing strategy that can help you buy properties with little to no money down, leverage the seller’s existing interest rate, and avoid the hassle of applying for a new loan.
However, it also comes with some risks and challenges, such as the possibility of the lender calling the loan due, the seller going into bankruptcy, or the property being underwater. Therefore, you need to understand how this strategy works, what are the pros and cons, and how to protect yourself and the seller from any legal or financial issues.
