Myth #1: Buying A House “Subject-To” The Existing Mortgage Is Illegal.

Absolutely not true! Some states are attempting to pass legislation to regulate “subject-to purchases because of unscrupulous investors. Check with your local attorney to determine the status in your state because most still have no laws passed.

This myth has been around a lot longer than these new laws in a few states. The reason is that most mortgages have a “due-on-sale” clause which states that if the house is sold without paying off the mortgage, the lender has the “right” to call the entire loan due. The key here is that they have a “right” – not an “obligation”. In other words, it’s their choice. Before doing my first “subject-to” deal I asked several attorneys in town who represent lenders to see if they had ever heard of a bank call a loan due because of a sale. In every instance they said: not as long as the payments were made timely. Why? Because banks are in the money business – not in the real estate business. If they call the loan due, and it goes into foreclosure, they have a poor performing loan on the books (for which they have to increase their reserves), they incur additional costs, and they inherit a property. Their other choice is to just continue to accept timely payments from the new owner. Which makes more sense? 

Note: This is only true when the mortgage holder is a bank. If the mortgage holder is a private individual, they may in fact prefer to have the house rather than timely payments.

Myth #2: Buying “Subject-To” Is Complicated And Requires A Ton Of Paperwork.

 The truth is that all you have to do is write it into the Purchase and Sales Agreement (PSA). I write it in right next to the Purchase Price. Here’s an example using my PSA:

Total Purchase Price to be paid by Buyer is $80,000.00, payable as follows: “subject-to” existing first mortgage with Acme Finance with a balance of approximately $77,500, and monthly PITI payments of $695; remainder of Sellers equity to be paid in cash at closing.                       

That’s it. You and the Seller have now agreed that you’ll purchase the home subject-to their mortgage. As a precaution, I have the Seller sign a disclosure that they know and understand that the loan has a due-on-sale clause which the lending institution can invoke since the property is being sold. It also discloses that I make no promise as to when the loan will be paid in full, or how long it will remain in their name. I also prepare a letter from the borrower informing the bank that all future correspondence should be forwarded to me, and that I have the right to act for the Seller in every way regarding the loan so they’ll disclose loan information to me in the future. 

It really is that easy. After closing, you just start making the payments. I don’t hide my identity from the bank. I send in my own checks, and the house insurance is in my comapny name.

Myth #3: No Homeowner Will Ever Sell Me Their House And Leave The Loan In Their Name.

If you’re dealing with a seller who has no problems with his house, this may be true. But when you deal with motivated sellers – ones that either have financial, personal, or house issues – this will not be an issue. Motivated sellers need a way out – quickly! Often, they’re already behind in their payments, and facing foreclosure. When you tell them that their worries are over, and you’ll catch up their back payments, and make all the subsequent payments on time they’ll jump at the opportunity. As a bonus, their credit will even improve. 

The key to successful negotiating lies in your confidence. Realize that you’re providing a viable alternative solution which allows the highest price to be paid, with the quickest closing, and immediate relief for the Seller’s situation.

Myth #4: Kitchen Table Closings Are Perfect For These Transactions

Investors love to say that they “got the deed” at the kitchen table when they presented their offer. The concern is you have no validation of what you purchased. Without a title exam, there’s no guarantee the correct owner even signed the deed, nor whether any other loans or liens exist on the property. You also have no title insurance to protect you from any unanticipated title problems. Finally, the actual payoff on the loan must be validated with the lender by requesting a statement of account. Do not use the principal balance payoff shown on the monthly statement because it does not include past due payments, other interest accrued, fees and penalties, and any prepayment penalties. I have seen actual payoffs tens of thousands of dollars greater than the principal payoff. 

You could argue that what difference does it make if the loan isn’t in your name and you gave the Seller no cash. The problem is that you may not discover any of these issues until much later in the transaction – maybe not until you try to sell the property. By then, you will have invested time, energy, and money in the property only to see it all lost, when all of these problems could have been avoided by conducting a standard closing with your attorney or title company.

Myth #5: I Can Always Just Walk Away If I Can’t Pay The Mortgage

This is technically true, but not a great strategy for the successful investor. Legally, you are not responsible for the payments, although some states are attempting to pass legislation to stop investors from just walking away. You also have your credibility and reputation to consider – which are critical to your long term success. You definitely don’t want an angry seller defaming your reputation in the community, or submitting a complaint with the Better Business Bureau. Not to mention that you probably have cash invested in the house, which will all be lost. I recommend treating “subject-to” mortgages just like any other with your name attached – make timely payments.

Best of Success & Abundance,

Lou Castillo,
Real Estate Investing

National Trainer and Mentor....
www.InvestorRiches.com