Subject to Mortgage vs. Assumption of Mortgage

Considering the shortage of money and abundance of bad credit it’s no wonder these two terms are coming up more often. I’m not here to teach you how to broker either one of these deals, but rather just set you straight on what they are, define/clarify some terms  and offer my input on  some of the benefits, risks, etc.

First and most importantly, let’s get the language down first.  A subject to deal is not the same as an assumption which also means the terms are not interchangeable.  Please… stop doing this. You will get yourself into major trouble by promising a deal using one term when what you are really intending to do is another – innocently or not.

SUBJECT TO MORTGAGE

A subject to deal is when you agree to purchase a property subject to the existing mortgage already attached to the property. This means the existing loan will not be satisfied at closing. In a conventional deal, that existing mortgage would be paid off at closing and a satisfaction and release of lien would be recorded by lender. In a subject to deal, nobody is paying off the existing mortgage. It will remain a lien against the property and the lender is going to expect someone to keep making payments. If someone does not make payments the lender will take the property –regardless of what money you paid to the seller, improvements you made, or the fact that your name is on the Deed.

ASSUMPTION OF MORTGAGE

An assumption of mortgage occurs when a lender agrees to let you assume the payment obligations of the current borrower. There are two things to take note of in that sentence 1. An assumption requires lender approval and 2. The existing mortgage is not paid off. The liability of making payments  just shifts.

BENEFITS

If you have very little money to get started in the real estate game, and you are really good at talking people into giving you their property without giving them a bunch of money then I can see why these deals are attractive.

First, there is very little or no money down. You aren’t coming to the table with a big hunk of cash, you aren’t making a down payment, and you aren’t paying lender fees.

Second, if the deal goes bad, you as the investor are not liable to the lender for the defaulted loan. The seller is still the only guarantor of the note; however, heed this warning - you will be named in the foreclosure because your name is on the Deed - Yep. Hmmmm?

RISKS

Pretty much every well constructed loan has a little provision called a Due on Sale clause. This means that in the event the property is sold without lenders approval and without satisfaction of the loan, the lender may call the entire loan due and payable in full - immediately. Get it… Due - On - Sale? 

Many people are aware of their due on sale provision, but are of the opinion that the language is irrelevant. They say things like, “The bank won’t care as long as they are getting their money”.  Well, I am here to tell you that is not entirely true.

Also, think about this...what if your seller files Bankruptcy? After all, he was obviously having a hard time making his mortgage payments. That debt is going to be named in the bankruptcy petition and the trustee is going to want to liquidate that asset which is looking more and more attractive now that you fixed it up.  What if Seller gets hit by a bus and his estate must be probated? Things could get ugly real fast.

Be careful of the representations and guarantees you are making to a seller. The biggest mistake I hear investors make is telling the seller that since the buyer is taking over their mortgage payments the seller will now be free to go out and buy another house. NOT TRUE. Many sellers in a subject do deal believe that you are relieving a debt burden by taking over their payments. While it is true that by you making that mortgage payment seller will have more money in their account at the end of every month, but they are not relieved of the debt. As far as the bank is concerned, the seller (not you) still owes them the full balance of the loan, and it will still appear on their credit report. This means the seller probably can’t go out and get another loan until this one is paid off because their debt load will be too high.  

LEGALITY

Short answer, yes, these are completely legal.  There is no law that says you can not transfer title of your real property without getting permission from your lender first. There may be consequences, but there is no such thing as due on sale jail.

TITLE WORK

You absolutely can (and should) purchase an owners title insurance policy. The coverage will be just like any other deal except the mortgage will be appear in the exceptions part of the policy. It is very possible that if the seller is having a hard time making mortgage payments they are  having a hard time making other payments as well. There are lots of other things that could have attached to the property. Just go ahead and get that title insurance policy. 

GOOD IDEA vs. BAD IDEA

Obviously, if you have a choice, there are much simpler and cleaner ways of purchasing an investment home. However, if a subject to deal is your ticket into real estate investment then remember that full disclosure and transparency are absolutely essential in these transactions. Be sure your seller understands exactly what you are doing and exactly what they are and are not getting. I read an article about an investor who went so far as to require the seller to put down in his own handwriting exactly how he understood the deal to be. This may sound like overkill, but I sure would be glad to have it when some attorney for the seller’s estate starts claiming that I “stole” the property, committed fraud or misrepresented the deal.