While there are plenty of great strategies for finding good residential projects, subject-to real estate deals represent a hidden gem in the search for quality investment opportunities.
Subject-to real estate deals are definitely a lesser known strategy, but any serious investor should have a solid understanding of how these deals work. In this article, I’ll be diving into each of the following topics:
⦁ An overview of subject-to real estate deals
⦁ How subject-to deal work
⦁ Why subject-to deals are great options for investors
⦁ Risks of subject-to deals
⦁ Finding the deals
⦁ Are subject-to deals right for me?
What are Subject-To Deals in Real Estate?
Not all real estate purchases require qualifying for a loan, and subject-to real estate deals are one of these awesome opportunities.
With this strategy, an investor takes over the title to a property while the mortgage on that property remains in the seller’s name, or “subject-to” the existing financing.
As such, investors are able acquire properties without the hassle of qualifying for a mortgage and with no minimum credit score, an appealing approach for new investors building their portfolios.
How Do Subject-To Deals Work?
Here are the nuts and bolts of how subject-to deals actually work.
Typically, a homeowner falls behind on mortgage payments and becomes in danger of foreclosure. Once this happens, they either A) accept foreclosure and walk away from the property, or B) look for any exit option from the property that’s better than foreclosure.
For homeowners in these latter situations, subject-to investors extend a lifeline by offering to purchase the property. Specifically, the investor pays the past-due payments, assumes responsibility for the future mortgage payments, and takes title to the property while keeping the loan in the seller’s name.
Sellers avoid the crushing impact a foreclosure can have on their credit score, and investors acquire a property without needing to qualify for a new mortgage.
This is an absolute win-win.
Why Subject-To are Great Options for Investors
Successful real estate investors will stress that financing is king. For residential investors following the BRRR approach, it becomes progressively harder to apply for mortgages after you hit a certain threshold of financed properties.
In a 2009 effort to stabilize the post-Recession housing market, Fannie Mae increased its maximum-allowable number of financed properties from four to ten. Investors could now finance residential properties with up to ten outstanding mortgages.
However, due to the stricter underwriting standards, many banks still won’t provide loans to investors in the 5-10 mortgage category (to say nothing of investors seeking to build portfolios of dozens of properties). For example, here are some of the requirements imposed on these buyers:
⦁ 25% down (30% for 2-4 unit properties)
⦁ Minimum credit score of 720
⦁ No late mortgage payments within the past 12 months
⦁ At least two years of tax returns showing rental income from all properties
⦁ Six months of PITI reserves on each of the financed properties
These are tough standards to meet, and many investors simply can’t. Instead of jumping through these hoops, investors who take advantage of the subject-to strategy can continue acquiring properties—regardless of number—without the headaches of conventional financing approval.
Risks of Subject-To Deals
Before diving headlong into subject-to real estate deals, investors should familiarize themselves with the following risks associated with the strategy:
⦁ Due-on-sale clauses: Nearly all residential mortgages include a due-on-sale clause that prevents a buyer from assuming the seller’s loan and its terms. This is essentially a call option for the bank, and while most lenders don’t actually enforce it, a subject-to investor runs the risk of the lender calling the original loan once title is transferred. This could leave both the investor and the seller in difficult financial positions.
⦁ Bankruptcy proceedings: If a seller’s truly in financial hardship (which he or she likely is if approaching foreclosure), filing for bankruptcy is an option. When sellers file for bankruptcy, the loan can be included in bankruptcy proceedings, with the house foreclosed on by the original lien holder, regardless of the fact that title has been transferred to the investor.
Neither of these risks are deal breakers for investors pursuing a subject-to strategy, but you should absolutely develop contingency plans that account for the possibility of needing to address either bankruptcy proceedings or a due-on-sale call.
How Do you Find Subject-To Real Estate Deals?
Now that you know how subject-to deals work, where can you find the actual pre-foreclosure opportunities? Each market’s going to be different, but here are some pretty standard options for finding homeowners in these sorts of situations:
Use a Foreclosure Real Estate Agent
Like investors, most realtors carve out a particular niche. Larger markets typically have agents who focus solely on houses in the foreclosure pipeline, and they can be a great lead for properties that are nearing this status.
Use the Zillow Filter for Pre-Foreclosure Properties
In the “listing type” option, select “for sale” and ensure the “pre-foreclosures” box is checked in the drop-down menu.
Check your Local Newspaper
A Notice of Sale is required to be listed in the local newspaper prior to any foreclosure sale. By this point in time, the option to make a subject-to offer to the homeowner may be too late, but it’s still a good resource.
Drive-bys
Drive through a neighborhood where you’re interested in buying and look for foreclosure signs. Most of these will have a real estate agent listed who you can call to ask about any other potential foreclosures.
Fee-Based Sites
As always, you can pay for this information if you’re looking for a shortcut. There are plenty of subscription options available for investors looking to get early—and regular—information on potentially upcoming foreclosures.
Are Subject-to Deals Right for Me?
Armed with the above information, investors need to decide if the subject-to strategy is right for them. Here are a few questions to ask:
Am I worried about qualifying for conventional mortgages?
Is my goal to build a portfolio of rental properties that surpasses Fannie Mae financing limits?
Am I willing to actively seek out these sorts of deals?
Am I willing to accept the risks associated with subject-to deals?
If you’ve answered yes to the above questions, give this strategy a shot. And, as with real estate investing, in general, two strategies aren’t mutually exclusive. While the subject-to approach may make sense for one deal, another strategy may make sense for the next one.
The most important thing is just taking action, that is, starting to invest!
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No matter what path you take as a real estate investor, financing is king. Without access to reliable financing, the best deals remain nothing more than wishful thinking. As such, one of the most important relationships you can build as an investor is with a reliable, trustworthy lender.
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