Subject-To Loans: How to Buy Real Estate Subject to a Mortgage

As you research creative financing for real estate deals, you’ve probably come across the concept of buying properties subject to a mortgage.

But what does that actually mean?

Subject-to loans can work particularly well for real estate investors with weak credit, who have trouble getting approved for rental property loans. But subject-to financing can also save you money on interest and fees, and adds another option to your “financing toolkit” of ways to buy properties.

What Is Subject-To Financing?

When an owner sells their property, they’re supposed to pay off the mortgage loan in full, per the “due on sale” clause (more on that later). But not all sellers do.

Instead, the buyer and seller sometimes work out an arrangement where the buyer takes over the existing mortgage. They make the monthly payments moving forward. In other words, they buy the property subject to the existing mortgage.

That leaves the seller legally on the hook for the loan however, with personal liability. If the buyer defaults, or makes their monthly payments late, it can hurt the seller’s credit score, and they can even end up with a deficiency judgment.

Even so, buyers don’t want to lose their new property to foreclosure. And often sellers retain other cards they can play if the buyer defaults on the subject-to loan.

How to Buy Real Estate Subject to a Mortgage

Imagine you approach a seller about buying their $200,000 property. They have a $150,000 mortgage principal balance with 20 years remaining on the loan term, at 5% interest.

You offer to buy the property subject to their mortgage, and pay them the difference of $50,000 in cash at the settlement table. This helps you in several ways. First, you score a loan with a low interest rate. Second, you avoid paying any points or fees to a new mortgage company at the settlement table.

Just as importantly, but often overlooked, you skip the first — and worst — years of amortization on the mortgage loan. You step in ten years into a 30-year mortgage, and avoid those initial years when most of each monthly payment goes toward interest.

That said, you also have to make monthly payments on a loan for a higher initial loan amount.

Finally, you don’t have to qualify for a new rental property loan, which removes your credit history from the equation.

Alternatives to Subject-To Loans

You can also look at variations and alternatives to subject-to loans, as part of your creative financing toolkit.

To begin with, you could borrow your own rental property mortgage to pay off the seller’s loan, and borrow a seller-held second mortgage. To continue the example above, you agree on a $200,000 purchase price, you borrow $160,000 from a portfolio lender like Visio or Kiavi, then borrow another $30,000 as owner financing from the seller. You put down the remaining $10,000 in cash as a down payment.

Alternatively, you could work out a wrap around mortgage with the seller. They provide you with $190,000 in owner financing at 7% interest, and you put down $10,000 as a down payment. But they don’t actually pay off their old mortgage — they leave it in place, continuing to pay only 5% interest on their balance while earning a spread on the interest they charge you.

The seller could also structure the deal with you as an installment contract. Rather than transferring the title of the property to you right away, they leave it in their name for the first few years as you make loan payments. This lets them keep their old mortgage open with no fear of it being called based on the due on sale clause. When you pay down your seller financing balance below a certain level, they transfer the deed to your name.

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5 Tips for Subject-To Loans from Real Estate Experts

Have questions about buying properties subject to a mortgage? Of course you do — it’s an unusual maneuver.

Try out these seven tips from professional real estate investors to make your first subject-to financing deal silky smooth.

1. Offer The Seller Cash Too

The average home seller just wants to sell their house for top dollar, pay off their mortgage, pocket the rest, and never look back. “For a seller to consider selling their home subject to the mortgage, they need a good reason. That could be trouble with making their mortgage payments, keeping up with necessary repairs, or other life stressors.

“It helps to present a subject-to offer in tandem with some other type of offer, such as a cash offer. This changes the dynamic from a ‘take it or leave it’ offer to them being able to choose which one works best for them.

“Make sure you understand how the seller’s prospects for future loans could be affected if you buy their house subject to a mortgage and they leave their old loan open. At worst, a future lender will view it as a rental property with you as the tenant and give them a 75% credit on the payment on their debt-to-income ratio.”

—Jordan Fulmer

Real Estate Investor and Founder of Momentum Property Solution

2. Watch out for “Due-On-Sale” Clauses

“Most banks include something called a due-on-sale clause in their mortgages. This means that when real property is sold or changes title, the total outstanding balance on the mortgage is immediately due (hence the name). Since the property is changing title during a subject-to financing deal, this could trigger an alert at the bank and make them come after the seller for the money.

“That said, some older/smaller banks don’t have these systems in place and, as long as they’re still receiving the monthly payments, never find out that a property has changed title. I’ve heard of many cases where this happens. Nevertheless, this is something to watch out for.

“Make sure a real estate attorney is involved. In most subject-to financing deals, the buyer has no legal obligation to pay the mortgage even though they now have title to the property. This is because the loan is still in the seller’s name. Hence, the buyer could technically only pay the property tax and stop paying the mortgage. Due to this legal murkiness, make sure that you have a real estate attorney advise you on subject-to financing deals so that you’re legally and financially covered for all contingencies.”

A title company can help you cover your legal bases here as well, from preparing a legal contract between you and the seller to double checking that property taxes are up to date.

—Marina Vaamonde

Owner and founder of HouseCashin

3. Treat the Loan as if You Have Personally Signed The Mortgage

“The simplest, quickest, cheapest, and least complicated way to purchase property is subject to the seller’s mortgage. However, contrary to popular belief, it is not without risk.

“One danger is that the seller declares bankruptcy. In this case, you own the house and its equity, but the original borrower still owns the financial commitments to the subject-to loan. The loan might be included in the bankruptcy, and the original lien holder could foreclose on the property.

“Accepting someone’s loan and agreeing to make payments on it is a major responsibility; anyone using this form of purchase should treat the loan as if he had personally signed the mortgage. Some approaches recommend putting the property in a trust and selling the trust’s beneficial interest to conceal ownership. This is an attempt to avoid the due-on-sale clause being triggered (which is found in most conventional mortgages).

“Subject-to is an excellent method to start building an income-producing real estate portfolio. Because the loans are not in your name and you never have to qualify, there are no restrictions on how many you can buy. Buying real estate subject-to also makes a fantastic tool for more seasoned investors, as it is one of the most efficient methods to generate wealth quickly.”

—Danny Marshall

Mortgage Broker Educator at Mortgage Rate Guru

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4. Do The Research

“First, make sure that the seller is actually the owner of the property and has the right to sell it. You can do this by checking the title history of the property or contacting the county clerk’s office.

“Second, make sure that you’re comfortable with the terms of the loan. The loan might be in default, so check the most recent loan statement.” Ideally, get access to the online account login for the mortgage loan you’re assuming.

“Finally, be sure to get a good understanding of how long the loan will last and what will happen if it’s not paid off on time.”

—Max Benz

Founder and CEO at BankingGeek

5. Prepare with Strong Credit & A Down Payment

“Make sure you have good credit. The seller will likely run a credit check before approving the subject-to loan. If your credit score is low, you may not be approved for the loan.” Work on building your credit score if that remains a weak spot for you.

“Have a down payment saved up. Lenders usually require borrowers to put down at least 20% of the purchase price of the property. If you can’t afford to pay 20%, try to save up as much money as possible so that you can reduce the amount of debt you need to take on.

“Be prepared to show proof of income.”

—Morshed Alam

Founder & Editor at Savvy Programmer

Final Thoughts

Buying real estate subject to a mortgage comes with plenty of advantages for buyers. Sellers also sometimes come out ahead, particularly through strategies like wrap around mortgages or installment contracts.

Always run the numbers combining all fees and interest for the entire life of the loan, when comparing your financing options.♦

Have you ever bought a property subject to a mortgage? What have your experiences been with subject-to real estate?

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About the Author

G. Brian Davis is a landlord, real estate investor, and co-founder of SparkRental. His mission: to help 5,000 people reach financial independence by replacing their 9-5 jobs with rental income. If you want to be one of them, join Brian, Deni, and guest Scott Hoefler for a free masterclass on how Scott ditched his day job in under five years.

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