Subject-to clauses can pertain to a number of things in a real estate transaction, from the right to an inspection to the buyer selling their existing property in order to purchase a new one. But with real estate investing, the term "subject-to" often refers to a creative way to buy or sell a property subject to its existing financing. For investors, there are benefits to using subject-to in buying or selling real estate, but only in the appropriate scenario. Read on to get a better understanding of what a subject-to clause is, as well as the pros and cons of buying or selling a subject-to property.
What is subject-to?
Subject-to financing is a legally binding clause of the contract that allows the buyer to purchase the property subject-to its existing financing, meaning the buyer takes over the payments of the current mortgage loan. The exact terms of a subject-to scenario can vary greatly, but most require some sort of down payment in cash to the seller, with the buyer taking over the current payments or possibly paying slightly more because of a wraparound mortgage.
Pros of using subject-to
Buying property subject-to can be a great way to structure a wholesale deal or flip so you don't have to waste time getting a mortgage approval or tie up your credit for something that will quickly be in another person's hands. In this case, you buy the property subject to any existing financing, maintain the monthly payments according to the terms of the loan, and pay off the balance once the property sells.
It can also be helpful for buyers who don't have good credit or those investors who already have several properties standing against their credit. The loan, the interest rate, and the associated credit score are all on the original owner, not the new buyer. This can really allow for significant leverage if the only thing out of your pocket is the down payment money.
Cons of using subject-to
While there are wonderful opportunities to be had from a subject-to clause, there are also several very real, serious risks that can be associated with this type of deal. The first of these is the fact that you're relying on and trusting that the seller, or buyer, is actually going to make the agreed-upon payments to the lender. If the seller decides to keep the money and run rather than pay the mortgage, you as the buyer could face foreclosure despite having paid the debt obligations. If the buyer stops paying, you as the seller are still on the line to maintain the monthly payments until you can pursue legal action to regain title to the property.
The second common issue is if their original mortgage has a due-on-sale clause. This would mean that the bank can call the full amount of the loan upon finding out or suspecting that this subject-to agreement has been made. There can be workarounds for this clause, but you should exercise extreme caution and have a viable plan B if you don't want to risk losing the property.
The Millionacres bottom line
Purchasing subject-to properties certainly has both pros and cons, which must be weighed for each property, but in many cases this can be a creative win-win for both parties. As with any real estate transaction, it's a good idea to consult with a licensed real estate attorney for advice on the matter before entering into any subject-to agreements.