In the place of the non-qualifying (or qualifying) assumable loan is another – more complicated – strategy for taking over existing loan obligations. It is commonly referred to in real estate investing circles as taking the loan "subject to" the existing mortgage.
A purchase contract can be written to buy the property “subject to” the existing loan, which means taking over the obligation of the owner. While this may sound similar to an assumption, it has a clear difference. With an assumable loan, you are contractually taking over the obligation to pay. The loan, in essence, transfers to your name. When a loan is taken “subject to”, the original borrower is actually still on the note and obligated to pay if you don’t. You can see that would be a dicey situation, and it’s best for both parties in the transaction to have legal advice as to what’s involved.
The Due on Sale Clause Landmine
Commonsense legalities aside, there are a few landmines related to subject-to deals. Since most loans today have a due on sale clause, which means the loan balance is due and payable upon sale or transfer of the property, taking over a loan "subject to" can still cause that clause to be invoked which can lead to a big financial mess. Because of this, subject to strategies are best done with the advisement of your attorney.
There are a lot of investors today who use the subject-to approach to take over people's payments and avoid having to get new financing. Typically, these investors are targeting homeowners in the early stages of defaulting on their loan. Their idea is to either give the owner some cash and/or take over the payments without formally assuming the loan. Their general game plan is to either:
a) try to mask the transaction from the bank so the bank won't know the property has been transferred, which would potentially lead to the loan being called, or;
b) simply not worrying about the bank at all, doing the subject to deal, and operating from the premise that the bank won't call a loan that is being paid on time, etc.
Both of these approaches assume that a bank will ultimately be or feel better off with an investor who is keeping up the payments rather than a homeowner who is slipping into foreclosure. Along with that belief is that a bank won't call a loan when it's performing, so the due on sale clause is somewhat meaningless....that calling a loan never happens when the payments are being made, and certainly not in this market.
Banks Do Call Loans - Don't Let Anyone Tell You it Never Happens
Let me tell you -- banks can and do call loans due and payable all the time under subject-to and similar arrangements. I just came across one in Phoenix within the last month, with the investor faced with the foreclosure. More important - it's really the original home seller who is now faced with the foreclosure because his name is still on the loan! Again...lots of landmines, and this technique should be guided by some professional legal advice.
But it's Popular with Wholesalers
I'll also note that investors who utilize the subject-to approach regularly are principally short-term "flipping" types of investors. The reason why the due on sale clause doesn't worry them is that they don't plan on holding the house long enough for the bank or anyone else to uncover that it's been transferred. These types of investors are in, get their money, and get the property in the hands of someone else before any of this potentially matters. But, for the long-term investor who wants to build wealth, the chances are, the due on sale clause is likely to rear it's head at some point. Then, you either have to negotiate with the bank to put your name on the loan (assume it) or get refinanced real quickly.
The Bottom Line
So, the bottom line on subject-to deals: useful for the short term investor, not so good for the long-term holding-type investor, and always have a lawyer in your corner.
