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Real Estate Investor University Newsletter
"News, Information and Education for Real Estate
Investors"
Created and Published by Donna Robinson
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How to Write "Subject-To" Offers
by Donna Robinson
A "subject-to" offer simply means that the buyer is willing to
purchase a piece of property "subject-to" some specific
circumstance. Usually that circumstance will be the sellers existing mortgage.
It can also be a variety of other things. One of the most common
"subject-to" clauses in real estate contracts is
"subject-to" buyers inspection. But for real estate investors, the
most common use of the term "subject-to" is in relation to purchasing
a property "subject-to" the sellers existing mortgage. This means that
at closing, the property is titled in your name, but the loan is still in the
sellers name. Therefore, you are buying the property "subject-to" the
sellers existing mortgage payments.
What are the advantages of "subject-to"?
The most common advantage is the idea that you are buying without the need to
qualify for a new loan. When you purchase a property "subject-to" the
existing mortgage, the seller is basically agreeing to allow you to take
possession of their property, and pay their existing mortgage payments. Since
you are not qualifying for a new loan, and the existing loan is in the sellers
name, it is the sellers credit that is at risk, not yours. This means that you
are buying without having to worry about having good credit.
Why would a seller agree to allow you to take over a loan that is in their
name?
There is definitely some risk involved for a seller who agrees to sell a
property "subject-to" the existing mortgage.
For one thing, if the buyer decides to walk away from the deal, or fails to make
those mortgage payments, the seller is the one who will suffer. A sellers credit
rating could be ruined by a buyer who fails to make the mortgage payments on
time.
Therefore, most sellers are very reluctant to agree to "subject-to"
terms.
Seller motivation is the most common reason a seller will agree to this
type of arrangement. There is usually some extreme circumstance or personal
issue that is forcing the seller to do something they might not ordinarily do.
This is why we often say that you are looking for motivated sellers, rather than
houses, especially when it comes to creative financing options.
I once did a "subject-to" deal with a seller who was getting married
and moving out of state. She had been trying to sell her property for several
months, with no takers. It was in a great area, in a nicer neighborhood, but the
house needed some updating and the colors were rather drab inside. Time was
running out. The wedding was only weeks away, and the seller was planning to take up residence with her new husband in his house.
Because of this she was motivated to sell the property any way she could.
She accepted an offer to buy her property subject-to the existing mortgage, for
two years. That meant that we had two years to get new financing and pay her
off. She understood the risk to her credit and was concerned, but we were able
to produce references and other documentation that made her feel comfortable
doing this deal with us. Had she not been in the position she was in, she likely
would never have agreed to accept a sale that would leave the mortgage in her
name, so motivation was the primary factor in this deal.
We updated the house, and sold it a few months later to a buyer who was able to
qualify for their own mortgage, so the seller got her money about a year and a
half earlier than expected. We had planned to lease/option the property to a
buyer if necessary, then help them get qualified for a new loan. As it happened,
we did not need to do the lease/option to get a buyer. Of course, we did spend
some money fixing the property up first. This helped us find a qualified buyer
faster than anticipated.
The "subject-to" arrangement allowed the seller to solve her immediate
problem. It also allowed us to buy the property without having to qualify for a
new loan. Everyone was happy.
Another time, I did a deal with an investor who sold to us
"subject-to" an existing mortgage on a multi-unit property. He
was motivated to get out from under the payments on this property due to some
other financial problems he was having.
When writing "subject-to" offers, you need to get the seller to
provide you with a copy of the current mortgage terms. You will want to include
these terms in your offer, so that they are spelled out to the letter. Below is
an example:
"Offer price $125,000 dollars, subject-to existing mortgage payoff of $95,780,
with payments of $789 per month, principal and interest, (the sellers current
payment) interest rate 6.5%, for 24 months. After 24 months, buyer will obtain
new financing and payoff existing mortgage balance. Buyer also agrees to pay
seller $5000 cash at this time".
So we are going to carry this note for up to two years, and when we either sell
or get new financing, we will pay off the sellers existing loan, and we will owe
the seller an additional $5000 in cash.
24 months is used in this example, but of course, your terms and time frame will
vary with each deal.
You can put in any terms you and the seller agree to. It just depends on the
situation and the level of seller motivation. Just keep it legal and moral. You
can't enforce terms in a contract that are in violation of existing laws, or
attempt to circumvent legal procedures that are required by law.
If the sellers payment also includes an amount for taxes and insurance, you
would want to specify that too. You want to be sure you clearly document the
exact terms of the existing mortgage. You will usually need your own
insurance in your name, since you are the title holder of record, even if the
mortgage is in the sellers name. Discuss this with your closing attorney to be
sure you handle this correctly.
The payment and interest rate are taken directly from the sellers
existing loan terms. You are merely documenting them in the offer, so that you
are clear on how much you are paying each month. If there are additional
arrangements, such as a second mortgage, or other terms you and the seller agree
to, you should make sure that they are also clearly documented in the offer.
Writing a good offer is really just a matter of making sure every specific
detail of your agreement is stated in terms that are clear. Should you ever wind
up in court over contract, a crucial issue will be the clarity of the terms in
the agreement.
You may want to have your attorney review the terms of an offer before you and
the seller sign it, to insure things are correctly stated. It
is pretty basic stuff, but if you need advice, get it BEFORE the seller accepts your offer.
Don't risk making a mistake if you are not sure how to word your offer. This
article is not intended to be a substitute for legal advice.
As with any deal where you are taking over the payments, you want to be
sure that your exit strategy will work with this existing mortgage. For example, if you agree to buy a property subject-to an existing payment
of $925 per month, and hold it for rental, be sure the rent will be higher than
the payment and expenses. This sounds like a no-brainer, but sometimes people
get so caught up in the idea of buying property without having to qualify, that
they forget to make sure that the numbers make sense.
If you are paying $925, but the property will only rent for $875, that ain't
such a great deal is it? Just because you can buy a property
"subject-to" does not mean you should. Make sure the numbers work for
the exit strategy you intend to use. If you are going to fix and resell, you
should check comps and be sure you can sell for an amount that is higher than the payoff on the existing
loan. Don't forget to include all of your anticipated expenses.
You should have at least $10K or more left as profit. Most professionals like to
see more than $10K. Some have a minimum $20K profit margin, simply because you
can always incur more expenses than expected. Extra profit margin in the deal
helps guard against losses.
Your offer price plus all repairs and expenses should not exceed 80% of what you
know the property is worth. (Note I did not say what you "think"
the property is worth) You must double check and be absolutely as sure as you
can be. Pay for an appraisal if you must, but the ARV has to be right. I
have suffered the consequences of that myself. It is an easy mistake to make,
even when you THINK you know.
Use 80% LTV as a general benchmark to judge your deal numbers. If total
cost is above 80% of the after repair value, the deal gets less and less
do-able. At 80% of ARV, the cash flow is generally positive and there is enough
margin to produce at least a 10K profit. The farther below 80% you can get, the
better. This is a good rule of thumb for those who are buying to hold for
rental or retail. It gets more difficult to break even if you get too far above
80% of ARV.
Closing a subject-to deal is like closing any other deal. Paperwork will
usually include a document that the seller will sign, which will be sent to
their mortgage company. It will notify the lender that the seller is now
assigning management of this property to "xxx management company". It
will also direct the lender to send all correspondence related to this property
to the management company address.
There is a long standing argument about whether "subject-to" deals
trigger the "due on sale" clause commonly found in virtually all
mortgages these days. This due on sale clause says that the lender can call the
loan due if they find that the title of the property has changed hands without
their knowledge. There are many people on both sides of this argument, but to be
honest, this is a change of title without the lenders direct knowledge, and in
my opinion, this could trigger the due on sale clause. But this almost never
happens as long as the payments remain current.
I have knowledge of many such deals, but have never heard of the lender calling
a loan due, unless it was behind on the payments. As long as you keep the
payments current, this will likely not become an issue. But, it is the lenders
right to do so if they wish. In that case, you would need to obtain new
financing, or sell the property.
Don't be afraid to do a deal this way, if the numbers make sense. Your
closing attorney can help you with the details.
Most any closing attorney who works with investors should be able to close a
subject-to deal for you.***
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The successful and the lucky have
something in common - Persistence
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Need some professional help with your real estate deal?
Do you understand all of the numbers?
Call me BEFORE you sign anything!
Private consultations or deal evaluation with Donna Robinson.
email drobinson@reihelp.com or call 404 542-9903.
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About the Author and Publisher of Real Estate Investor Weekly...
Donna Robinson is an investor, author, speaker, and publisher of
books and numerous articles on real estate investing.
A subscription to this newsletter is available at her website, http://www.realestateinvestoruniversity.com
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