On average, we pay around 2.5% of the purchase price in closing costs. Many real estate buyers––especially investors––are curious about ways to cut costs without lowering their quality of service. That’s where unconventional deals, such as subject-to, or subto, are growing in popularity.

What Does Purchasing "Subject-To" Mean?

“Subject-to”, or as we call it, "subto", refers to a creative financing strategy for buying and selling real estate. In a subto deal, the buyer assumes the mortgage payments of the seller without officially notifying the lender. The loan stays in the name of the seller, and as such, the home sale is literally “subject to” the agreement that states the buyer will satisfy the mortgage payments. The deed to the home transfers to the buyer, the same as any other sale. When interest rates are on the rise, subto deals can be a great way for buyers to take advantage of a seller’s fixed low-interest rates from years past.

How Exactly Does a SubTo Deal Work?

In subto deals, the remaining balance of the mortgage––the portion of the loan that the seller still owes––is considered part of the buyer’s purchase price. In other words, the seller’s debt is counted against the agreed-upon price, since the buyer will now be “subject to” that debt.

Release of Liability

When a borrower sells a mortgaged property subto, a release of liability can be used to help the seller qualify for their next mortgage. This instrument shows the next lender that while an outstanding mortgage is still in the sellers' name, the debt is no longer a contingent liability. The lender is now able to overlook the mortgage obligation as part of the borrower’s recurring monthly debt obligations and their debt to income ratio improves significantly. Many lenders will want to see that property purchaser using the subto deal structure has at least a 12-month history of making regular, timely payments for the release of liability to take effect. The lender can document this by obtaining: If the lender cannot document timely payments during the most recent 12-month period, the applicable mortgage payment will likely be counted as part of the borrower’s recurring monthly debt obligations and they may have difficulty qualifying for another loan. There are a few ways that subject-to deals can be structured. Let's take a look at a few examples:

Cash-To-Loan

The most straightforward subto deal includes the seller’s loan balance plus any additional cash that comes from the buyer to equal the agreed-upon purchase price. Let’s say two parties agree that the purchase price for a home will be $250,000. The seller still owes $200,000 on their mortgage. The buyer will take over those mortgage payments, and will pay $50,000 in cash to the seller (the difference between the purchase price and the loan balance).

Straight SubTo with Seller Carryback

This type of subto deal is similar to the first, except that the seller agrees to finance a portion of the purchase price for the buyer. Let’s consider the same example: Two parties agree that the purchase price for a home will be $250,000, and the seller has an outstanding debt of $200,000. But the buyer only has $25,000, so the seller offers owner financing for the remaining $25,000. The buyer then assumes two loan payments: the existing mortgage payment to the seller’s lender and the carryback payment to the seller for the $25,000.

Wrap-Around

In a wrap-around deal, the seller offers owner-financing that “wraps around” the existing mortgage, often at a higher interest rate. Again, let’s use the same scenario above: $250,000 purchase price, $200,000 mortgage balance $25,000 seller financing and $25,000 cash from the buyer. In a wrap-around deal, the seller offers owner financing to the buyer for $225,000. The buyer makes a down payment of $25,000 to the seller, and the buyer assumes the mortgage payment. In this type of deal, the seller may make additional profits by charging a higher interest rate than their existing mortgage. For instance, if the seller is paying 3% interest on their $200,000 mortgage and charges the buyer 4% interest on the $225,000 loan, they keep 1% on the portion of the payment that gets passed on to their original lender. And of course, they keep the full 4% on the portion that’s fully owner-financed ($25,000, in this case).

Why Would a Seller Agree to a SubTo Deal?

Most sellers that agree to sell with terms are in some sort of distress. Perhaps they're behind on their mortgage, or they are looking to free up cash due to some sort of sickness or divorce. Subto deals can help provide a quick solution to whatever problem they face. A common incentive for sellers who agree to subto deals is the positive effect the deal has on their credit since the mortgage is still in their name.

Why Would a Buyer be Interested in SubTo?

Real estate investors are the most common type of buyer using subto to purchase property. This type of deal offers lower cash requirements, fast closing, and potential profits on arbitrage between current market rent and the assumed mortgage payment. Subto deals are a great way to avoid closing costs and credit requirements imposed by lenders. They’re also a great way to start rehab and/or rental strategies quickly, which may lead to positive cash flow. As we mentioned earlier, subto is also a great way to benefit from low fixed interest rates when current market rates are on the rise.

What Are the Risks of SubTo?

For the buyer, there’s a risk that the property could be seized if the seller goes into bankruptcy. The buyer owns the property by deed, but the house is still collateral on the seller’s loan, which puts it into jeopardy in the event of bankruptcy proceedings. For the seller, there’s a risk that the buyer may default on the payments they’ve agreed to. In the event of default, the seller would be held responsible by the lender and the property may be foreclosed upon. Both parties are at risk if the mortgage is written with an acceleration or “due on” clause (which is common). When the property transfers hands, the lender has the right to call the loan due in full, if written with this type of clause. Most lenders pass on their right to call the loan due because they’re satisfied that someone’s making payments. But not always! Finally, because the mortgage remains in the sellers' name, some insurance providers will not offer coverage. It's crucial to find an insurance provider that will allow the buyer to purchase coverage. While there are many benefits that come with a subto deal, keep in mind that not every subto deal is a good deal. As with any investment, buyers should do their homework and exercise due diligence. Run comps, look closely at the ARV (after repair value) for rehab strategies and consider working with an experienced attorney. Subject-to real estate deals can be a good option for both buyers and sellers under the right circumstances, as long as both parties understand the pros and cons.