Myth #1: Buying A House “Subject-To” The Existing Mortgage Is Illegal.
Not true! 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. We asked several attorneys in town representing lenders to see if they had ever heard of a bank calling 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), incur additional costs, and inherit property. Or, they can accept timely payments from the new owner. Which makes more sense?
The truth is that all you have to do is write it into the Purchase and Sales Agreement (PSA). We write it right next to the Purchase Price. Here’s an example using our PSA:
Total Purchase Price to be paid by Buyer is $80,000.00, payable as follows: “subject-to” existing first mortgage with a balance of approximately $77,500, and monthly PITI payments of $695; the 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, we have the Seller sign a disclaimer that they know that the loan has a due-on-sale clause and that we make no promise as to when the loan will be paid in full or how long it will remain in their name. We also prepare a letter from the borrower informing the bank that all future correspondence should be forwarded to us. We have the right to act for the Seller in every way regarding the loan, so they’ll disclose loan information to us in the future.
It is that easy. After closing, you start making the payments. We don’t hide our identity. We send in our checks, and the house insurance is in our name.
Myth #3: No Homeowner Will Ever Sell Me Their House And Leave The Loan In Their Name.
This may be true if you’re dealing with a seller who has no problems with his house. But this will not be an issue when you deal with motivated sellers – those with financial, personal, or home issues. Motivated sellers need a way out – quickly! Often, they’re already behind in their payments and facing foreclosure. When you tell them their worries are over, and you’ll catch up on 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 that allows the highest price to be paid, with the quickest closing and immediate relief for the Seller’s situation.
Investors love to say they “got the deed” at the kitchen table while presenting 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 unanticipated title problems. Finally, the actual payoff on loan must be validated with the lender by requesting a statement of account. Please 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, or prepayment penalties. We’ve seen actual payoffs tens of thousands of dollars more significant 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. You may not discover any of these issues until much later in the transaction – may be 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 Walk Away If I Can’t Pay The Mortgage
This is technically true but not an excellent strategy for a successful investor. Legally, you are not responsible for the payments. But you have your credibility and reputation to consider – which are critical to your long-term success. You 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. We recommend treating “subject-to” mortgages just like any other with your name attached – make timely payments.
by Lou Castillo