Ever heard of a “subject to mortgage” and wondered what the heck that is?
Well, you’re in the right place.
This nifty term refers to a type of investment strategy where you, the investor, purchase a property subject to its existing mortgage. That means, instead of getting a new mortgage, you just take over the payments on the current one.
Why would you want to do something like this, you ask?
Good question! It’s because it can be a potentially profitable way to grow your real estate portfolio without needing to worry about up-front financing or qualifying for a new loan.
Of course, like any investment strategy, there are pros and cons to a subject to mortgage. We’ll dive into all that, plus give you a glimpse of what a real-life subject to mortgage deal looks like in the world of “sub 2” investing.
By the end of this post, you might just find that a subject to mortgage is the missing piece in your real estate investing puzzle.
What Is a Subject To Mortgage?
When we talk about a “subject to mortgage,” or “sub 2” for short, we’re talking about a pretty cool strategy that real estate investors can use to grow their portfolio.
Buying a property subject-to means you’re not going out and getting a brand new mortgage. Instead, you’re stepping into the seller’s shoes and taking over payments on their existing mortgage.
In essence, a subject to mortgage is like a relay race — the original homeowner starts the race (or in this case, the mortgage), and then hands off the baton (the mortgage payments) to you.
You then continue the race until you cross the finish line (sell the property) and the underlying mortgage is cashed out.
Why Invest in a Subject To Mortgage?
So, imagine this: You find a great property with an existing mortgage. Instead of applying for a new loan or hitting up your private lenders, you simply start making payments on that existing mortgage.
The deed is transferred to you, but the mortgage stays right where it is. This is what we mean by buying a property “subject-to” the existing mortgage. Clever, right?
And each month, when the mortgage company expects a check, they’re getting it from you, not the original homeowner.
Sounds pretty straightforward when we explain that way, doesn’t it?
Pros of a Subject To Mortgage
Now let’s dive into the advantages one by one, shall we?
1. Less Cash in the Deal
One of the biggest draws of a subject to mortgage is that it can be a bit lighter on your wallet, because the loan on the property is already in place.
This means you don’t have to cough up a hefty sum for a new loan at closing or bring in private money lenders. Sure, you’ll have some closing costs if you go through an attorney or title company, or if you decide to give the homeowner some cash for their equity…
But think about it this way: If the homeowner owes $100k on their house, that’s $100k you don’t have to bring to the table.
Not too shabby, right?
2. You Don’t Have to Tie Up Your Credit
Say goodbye to endless paperwork and signing your life away at a bank! and you won’t be hogging a private lender’s money, either.
With a subject to mortgage, you’re not taking out a new loan, which means your credit doesn’t come into play. This can be a huge plus if you want to keep your credit lines open for other investments or expenses.
It’s like having your cake and eating it too!
3. The Loan Has Aged
Here’s another neat thing about subject to mortgages: they often come with loans that have already matured a bit.
This means that many of the interest-heavy payments have already been made, and more of your payments will go toward the principal.
Imagine stepping into a loan that’s already in its 17th year of a 30-year term. That’s a whole lot of interest payments you’ve just sidestepped.
Cons of a Subject To Mortgage
Alright, we’ve sung the praises of subject to mortgages and highlighted their many perks. But let’s be real, nothing is perfect, and this strategy is no exception.
But don’t worry, for every con, there’s a way to overcome it.
1. Due on Sale Clause
One of the biggest potential roadblocks in a subject to mortgage is something called a “Due on Sale” or “DoS” clause.
This little clause gives lenders the option to call the loan due if the title to the property changes hands. So, if you take over the property, the lender could potentially demand immediate full payment of the loan.
Sounds scary, right?
But here’s the thing: Lenders are in the business of making money from interest payments. As long as they’re getting their monthly payments, they typically wouldn’t have a reason to call the loan due. It’s not impossible, but it’s unlikely.
To lessen the chance of a loan being called due, one strategy is to buy the property into a land trust. This way, even if the lender did a title search, it would show that the property was passed into the trust, effectively bypassing the due on sale clause.
Smart, huh?
2. Lack of Traditional Real Estate Knowledge
Subject to mortgages aren’t exactly mainstream, and many agents, brokers, and others involved in traditional real estate practices might not be that familiar with them. Some might even tell you that taking over someone’s loan is illegal, pointing you to the due on sale clause we just talked about.
But don’t fret! The key to overcoming this hurdle is education.
Take the time to learn about subject to mortgages (and don’t be afraid to educate others!). You’ll be surprised how much easier things become when you’re armed with knowledge.
3. Potential for Negative Equity
Like any investment, a subject to mortgage comes with a risk — the potential for negative equity if property values dip. This means you could end up owing more on the mortgage than the property is worth. Commonly referred to as “being underwater” on your mortgage.
But remember, real estate is a long-term game.
Property values can fluctuate over time, and a dip in value doesn’t necessarily mean you’re stuck in negative equity forever. Staying informed about market trends and having a solid exit strategy can help mitigate this risk.
What Does a Subject To Mortgage Deal Really Look Like?
Alright, we’ve talked about what a subject to mortgage is, its pros and cons. At this point, you’re probably wondering, “What does a subject to mortgage deal look like in real life?”
Well, let’s dig into a real-life scenario to give you a clearer picture.
Imagine this: An investor stumbles upon a house with a padlock on the front door. It’s clear the property has seen better days, but the investor sees potential.
In its current state, the property is valued at $80,000, but with some TLC, it could be worth a cool $130,000. The property carries an underlying loan of $100,000.
The homeowner is eager to stop making mortgage payments and open to selling. You, the investor seeing an opportunity, present the homeowner with a 3-tier offer structure.
Option 1: Cash Offer
The first option is a straightforward low-ball cash offer of $80,000. This is the no-frills, cut-and-dry option. It’s the lowest of the 3 offers… and it’s probably offensive to the seller. That’s ok… because there are 2 other offers to come. This offer sets the next 2 offers up as being better and more worthy of consideration.
Option 2: Small Down Payment with a Seller Carried Second
The second option mixes cash and seller carry. See, you’ll create terms that are good for the seller, offering more than just cash. This is for those sellers who say they want cash up front, but don’t need it all at one time.
Option 3: Seller Financing
This one means the least out of pocket from you. Along with advantageous terms, this option allows you to make the highest offer. This is the ultimate win–win. The investor controls a new property with no money out of pocket, the seller gets his/her house sold and will receive a monthly income.
So…
After some negotiation, the homeowner agrees to sell when the offer is increased to $105,000. The investor purchases the house for $105,000, with an after-repair value (ARV) of $130,000.
One important thing to note here: Because the investor takes over the underlying loan, they don’t need to secure private money financing. They plan to fund the renovations needed to bring the property to its potential value. How? Whelp, it’s super simple to get second mortgages behind bank-carried first mortgages.
And here’s another interesting twist: The investor has the potential for buying the property through a self-directed IRA account. This can be a savvy strategy for those looking to grow their retirement savings.
The Bottom Line About a Subject To Mortgage
And there you have it!
We’ve journeyed through the ins and outs of the subject to mortgage. From understanding what it is (taking over an existing mortgage instead of applying for a new one), to exploring the reasons why investors may find it attractive (hello, no need to qualify for a new loan or secure private money!).
So, what’s the bottom line?
A subject to mortgage isn’t for everyone, but for those willing to navigate its complexities, it could be a game-changer. It’s a unique tool in the real estate investor’s toolbox, one that can offer avenues for growth that traditional financing might not provide.
Now that you’re armed with all this info about subject to mortgages, why not consider whether this strategy could fit into your investment plans?
After all, diversification is key, and a “sub 2” might just be the unexpected ingredient that spices up your portfolio.
Happy investing!
