“Subject to” real estate sales are a new twist on an old scheme, promoted as a way to “control” significant amounts of real estate with minimal investment and virtually no risk. The name comes from the idea that the real property will be purchased “subject to” an existing mortgage, eliminating the need for the “Buyer” to qualify for a mortgage, and allowing the “Seller” to contract for an inflated price for the property. Unfortunately, the middleman – typically either a realtor or an investor -is the only person likely to emerge from one of these transactions with a profit. Subject to real estate sales are taught in seminars run by various investment groups. However, such deals are rarely – if ever -properly documented, leaving both parties at risk, violating the terms of the existing mortgage, and creating title problems that are expensive to unravel.
In the past, the usual method of buying property without paying off the existing mortgage was for the Buyer to assume the mortgage. The Seller received some upfront payment by the Buyer to cover the equity in the property (if any). The Buyer received possession of the property, a deed, and signed a Deed of Trust to the Seller to secure the assumption. The Deed of Trust allowed the Seller to foreclose if the Buyer failed to make the mortgage payments.
Virtually all mortgages now have a “due on sale” clause, which means that if the property is sold without paying off the mortgage, the mortgage is in default and the entire debt can be due. For now, a bank will rarely accelerate the mortgage, as long as payments are made timely. However, when market interest rates rise, one should expect that banks will begin actively seeking out sales which violate the due on sale clause, resulting in either a sudden need for an expensive refinance, or a foreclosure.
Of course, the people profiting from teaching and arranging subject to real estate sales will tell you that 1) the lender doesn’t care about the terms of the mortgage loan, 2) will not foreclose as long as payments are being made, and 3) that both “Sellers” and “Buyers” both benefit from these transactions. Nothing could be further from the truth.
As taught by the promoters, a subject to real estate sale will be closed at a title company, and the Buyer will receive a deed which states that it is granted “subject to” the existing mortgage. The sales contract will be modified to show the terms of the deed to the Buyer and detailing the Buyer’s obligation to pay the mortgage as a part of the purchase price of the property. In practice, title companies will not insure such transactions, and will not want to participate in a closing which violates the existing mortgage. As a result, these deals do not involve any title search or insurance, and typically are documented using a standard TREC contract, calling for a warranty deed, which the Seller can’t legitimately provide. Therefore, one of two things will be true – either the transaction will not be closed according to the sales contract, leaving the Seller in breach of the contract as soon as the deal closes, or the Seller loses title to the property and is subject to a potential foreclosure at any time.
Alternatively, the Buyer may never receive any interest in the property in exchange for their “down payment.” Instead, the “down payment” is simply split between the “Seller” and the middle man, and/or the middle man will enter into a contract to buy the property, and merely holds the contract until they have a Buyer to whom they assign their rights – for a fee. The middleman never acquires title or possession of the property and doesn’t intend to. They only plan to collect a fee.
To illustrate these issues, here are two scenarios which recently resulted in litigation and losses to the parties:
A Businessman with good credit was approached by a Realtor friend, with a “Buyer” who can’t qualify for a mortgage on the house he wanted to buy. Realtor friend convinced the Businessman to purchase the house with a mortgage in the Businessman’s name, and let the “Buyer” make the payments. “Buyer” and Businessman have only a verbal discussion that “Buyer” intends to “refinance” the property in a year to put the mortgage in their own name.
Businessman obtained a mortgage, bought the property, and paid a commission to Realtor. “Buyer” then discovered that he couldn’t insure the property because he didn’t have title. So, the “Buyer” forged a deed to himself from Businessman. Twelve years later, the “Buyer” stopped making mortgage payments, and the Businessman was facing foreclosure, he consulted an attorney and discovered the forged deed. After expensive litigation, the “Buyer” was evicted from the property, and the Businessman received a substantial judgment against the “Buyer” based on the forged deed.
In another transaction, a woman wanted to buy a house, but could not qualify for a mortgage. Her Realtor prepared a contract for purchase which under which she would receive a warranty deed and title insurance, with seller financing. Buyer’s $29,000.00 “down payment” is used to pay the Realtor’s commission, with the balance paid to the “Seller.” However, Buyer received only keys to the house and never received a deed, or title insurance, and there was no seller financing. She moved into the property and began making mortgage payments on the “Seller’s” mortgage. “Seller” then defaulted on the mortgage and left the country. The mortgage company foreclosed, and the ”Buyer’s” entire down payment was lost.
When buying or selling real property, especially with unusual terms and conditions, consider talking to a lawyer. It’s far cheaper to have the potential problems revealed before the transaction closes than after, so if you have any questions about your purchase or sale, call your favorite lawyer because it Feels Good to Prevail!