Subject To Real Estate Transactions Guide
“Subject to”, also known as “Sub To” or “Sub-To,” is a real estate transaction structure that is growing quickly in popularity throughout Oklahoma and across the country. The sub-to deal offers both buyers and sellers unique opportunities to streamline a transaction by bypassing traditional financing options; however, there are a lot of complexities to these transactions and it is crucial for all sides to be well-informed (or well-represented) to ensure a successful and secure arrangement.
What is a subject-to real estate transaction?
What it is: a buyer takes ownership of a property subject to the existing mortgage. This means the seller’s mortgage stays in place, which is completely different from the standard residential purchase and sale process where the sale proceeds which are paid by the buyer are used by the seller to first pay off the existing mortgage before paying themselves. Under a sub-to, the buyer assumes contractual responsibility (only between seller and buyer) for making seller’s mortgage payments.
What it is not: assumption of existing mortgage loan where the lender approves of a buyer taking over the seller’s mortgage terms, and buyer is formally and expressly substituted for the seller in the loan documents.
Why are subject-to deals growing in popularity?
This is a direct result of multiple market factors including historically low mortgage loan rates (such as the lowest recorded rate in January 2021 being 2.65% for a thirty-year fixed rate mortgage), followed by multiple successive rate hikes resulting in the doubling of rates (almost 7% in November 2022). Because the rates are substantially higher for new loans, buyers and real estate investors are looking to alternative deal structures which can help with lowering all-in costs for obtaining new properties.
This structure allows the seller to quickly get out of the responsibility to pay their mortgage, while allowing the buyer to avoid the hassle of having to be approved for a conventional loan in order to obtain ownership of a property. If the sub-to buyer makes the mortgage payments as planned, the seller may even positively benefit from increased credit history and performance; however, if the buyer defaults, the seller is put in a position with substantial risk and legal liability.
Sub-To Risks to Buyer
- Limited access to inspect the physical property condition (remember that the RPCDA still applies)
- Legal/paperwork due diligence is more important than in a standard transaction – some title companies even refuse to close sub-to transactions because of this risk (the title company has actual knowledge of a conflicting claim to ownership/possession of the property, so they may struggle to issue title insurance policies to buyers)
- Inheriting the existing/continuing mortgage and promissory note terms (this includes the due-on-sale clause, also known as acceleration)
- Ensuring proper transfer of property title – a very limited deed known as a quit claim deed is often used in these transactions, which does not provide any guarantees or warranties to the buyer (may intentionally create a cloud on the record title)
- Intentionally jumping in the back of the line behind the lender and the seller
- Ensuring the seller actually leaves the property – eviction (known in Oklahoma as “forcible entry and detainer” or “FED”) can be very difficult in these transactions
- Not ensuring enough margin – these properties are almost exclusively used as rental units after the sub-to closing, so if the due-on-sale clause is triggered by the lender, the deal may not “pencil” at a higher rate when the seller has to find a new purchase money mortgage
Sub-To Risks to Seller
- Affirmatively and intentionally breaching the mortgage terms – the lender has gone to great lengths to protect their loan investment in the property and wants to maintain contractual privity with the buyer/occupant at all times
- Do you trust the buyer? The seller will become tied to the buyer for the remainder of the loan term – sometimes as long as 25-30 years. The seller is allowing the buyer to completely skip the highly-regulated federal lending requirements, background check process, credit check process, etc.
- The buyer could “stack” multiple sub-to deals on top of the current transaction unless the parties agree that the existing/continuing mortgage must be paid off if the property is transferred again.
- Seller will be a key defendant in any foreclosure action instituted by the lender – the nature of a sub-to deal means the seller is releasing ownership of the property by executing a deed but maintains full liability for the mortgage default as far as the lender is concerned.
- Significant impact on credit and ability to obtain future loans – because the mortgage isn’t being paid off, the seller’s debt-to-income ratio will be impacted for the foreseeable future, making additional car loans, home loans, student loans, and personal loans possibly very difficult to obtain.
Other Subject To Risks
Parties should also be particularly careful in the following scenarios:
- The existing/continuing mortgage is a VA loan
- The seller is already in default or pre-foreclosure
- One of the parties is a non-natural person, such as a trust, LLC, or other entity
- “Wrap around” subject to deals (where the sub-to seller adds additional interest on top of the existing/continuing mortgage interest rate)
- What happens to the non-fixture personal property, such as appliances?
- Who is responsible for any liens which may exist?
- If the seller has owned the property less than two years (capital gains tax concerns)
What is the due-on-sale clause?
Most mortgages contain a “due-on-sale” clause, also known as “acceleration” or “due-on-transfer”. This type of contract term typically includes language that requires the borrower (who is the seller in a subject-to transaction) to pay off the entire mortgage loan balance upon the sale or transfer of interest in the property to a third party (meaning anyone who isn’t the bank or the original borrower). In the subject-to transaction, the seller is intentionally violating this term in the hopes that the lender will not enforce this term because the lender is still being paid the mortgage payment each month (assuming the buyer continues to pay).
Why You Need Legal Advice For a Subject-To Transaction
Whether you are a seller or buyer in a subject-to deal, you should insist on having a knowledgeable and experienced real estate attorney review your transaction documents before you sign. The risks for both parties are substantial and, in our experience, “what can go wrong, will” with these deals.
Contact the attorneys of Avenue Legal Group for help with subject to real estate transactions, whether you are buying or selling using the subject to structure, want assistance with closing a subject to deal, need a basic document review for peace of mind, or want to purchase subject to document templates.
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