A “Subject To” deal, or “Sub2,” is a method for buying real estate… without actually purchasing it. I know, that sounds a little crazy, but hear me out.
Imagine talking with your neighbor, Joe, about his house. He recently lost his job and can no longer afford to keep making the monthly payments on his house. He owes about as much as the property is worth (no equity) – so he can’t easily sell because the agent fees and other costs would cost too much money out of pocket. Joe is stuck… and in danger of losing his home.
So what can Joe do?
Introducing the “Subject To”
He could sell his house to you, of course!
However, you might not have enough cash to buy the property and maybe you don’t even have enough for a down payment to get a loan from the bank. So you decide to buy the house “subject to” the existing financing. What this means is: the existing financing – Joe’s mortgage- stays in tact. You simply take over the payments and start sending the check each month to his mortgage company. The loan stays in Joe’s name (though he moves on completely) and the property transfer’s to your name.
Is Buying “Subject To” Illegal or Morally Wrong?
No, definitely not illegal. In fact, buying a property “subject to” the existing financing is actually directly written on the “Hud-1”- the official standardized government settlement sheet that all US real estate sales use – on lines 203 and 503.
However, there is a risk associated with a Sub2 purchase, known as the “due on sale” clause. Essentially, the “due on sale” clause is a legal clause put into nearly every modern real estate mortgage that basically states “if the title is transferred, the lender has the right to call the loan due immediately.”
In other words- the bank could require Joe to pay back the loan immediately after you take over. If he can’t (which, obviously, he couldn’t) then the bank could foreclose on Joe. However, before you immediately dismiss the idea of a subject to deal, let me point out a few things:
- Banks generally, by and large, do not ever call the note due. The key to the due on sale clause is that they “could.” Most investors who utilize the subject 2 deal often have never had a loan called due. Some argue, though, that once interest rates start to rise, banks will begin calling more due to force borrowers to refinance and pay higher rates.
- The seller was on the verge of going into foreclosure anyways. In the story above, Joe had limited options and was about to go into foreclosure anyways. So, even if the bank did decide to call the note due – and you couldn’t negotiate your way out of it – you are personally not at any risk because the foreclosure is on Joe, not you. I’m not suggesting that you should take advantage of the seller using a subject two sale – but if the seller was on the verge of going into foreclosure anyways – at least you could hopefully have given more time for them to figure something out. In other words – never talk a seller into a subject to deal. Only do a subject to if that is a solution that the seller needs and truly wants.
How to Buy “Subject To”
Buying a property subject to the existing financing is actually very similar to buying any other property. You will want to do the same due diligence as buying a regular investment property, including a property inspection, title search, title insurance, and verification of all facts/figures of the property. It’s important to be sure the existing mortgage is not an adjustable-rate mortgage, especially if you plan to hold the property for the long term. You don’t want the rate, and payment, suddenly doubling while you holding the property.
Whether you live in a state where an attorney closes a real estate transaction or you live in a state where an attorney closes the loan – simply let your closing agent know that you will be purchasing the property subject to the existing financing and you’ll be fine.
Depending on the specific deal, you may need to bring money to closing in order to bring the existing loan current. In other words – if your neighbor Joe was $4000 behind on his payments/fees – you will want to make sure the existing mortgage company is paid all the fees needed, or else they may foreclose on Joe and take back the house from you. Not cool. Make sure the property is current on it’s existing financing or make it that way.
Finally, closing should happen in an uneventful manner. You will sign, Joe will sign, and the new deed will be recorded at your local county. Keys will transfer to you, and the house is now yours. But… how do you make money this way?
How to Profit from Subject To Investing
There are several strategies you could use to profit from investing in real estate using the “subject to” strategy. No matter what method you choose, I would recommend one important requirement: cash flow. If you can take over the existing financing and rent the property for significantly higher than your monthly payment – you can collect extra income each month while the tenant pays down the loan and the property values rise. Investing in real estate with negative cash flow is simply a recipe for your eventual financial demise.
- Many Subject To investors choose to simply rent the property out with no specific end in mind – other than the cash flow. They don’t plan on selling any time soon, but are content with the extra income each month.
- Other investors like to “lease option” the deal. In other words, the investor offers a “rent to own” program to a tenant, giving them the exclusive legal right to purchase the home from you within a pre-defined amount of time for a pre-defined price. For example, if you purchased your neighbor Joe’s house for $100,000 (taking over the existing financing), you could offer to sell the home for $130,000 to renter Sally any time in the next two years. Sally would then have two years to obtain a mortgage and pay off your (and Joe’s) loan.
- Still other investors simply look to “flip” the property to a brand new buyer for a higher price, who would then obtain their own financing and cash you (and Joe’s loan) out completely. There are several ways to do this, such as fixing the property up beautifully (HGTV style!) and sell it to a retail buyer or simply selling “wholesale” to another investor.
Buying “subject to” doesn’t need to be your only strategy to invest in real estate – but it definitely should be one tool in your tool box for solving people’s problems – which is the job of any good real estate investor. If you have any questions, I’d love to chime in. Leave your thoughts below in the comment section and let’s talk about it!
Would you do a “Subject To” deal? Why or why not?
Brandon Turner is an active real estate investor and Senior Editor at BiggerPockets.com, the real estate investing social network. He enjoys writing epic long blog posts, such as his Ultimate Guide to Tenant Screening and The Ultimate Beginner’s Guide to Real Estate Investing.