What is ‘subject to’ in real estate?

With the current real estate market featuring higher interest rates, tighter lending standards, and limited inventory, investors and everyday home buyers and sellers are sometimes getting creative in their transactions. Enter the option of “subject to” deals.

So, what is “subject to” in real estate? Simply put, it’s a real estate deal where the buyer takes possession of the home, agrees to keep paying the seller’s mortgage, and doesn’t take out a new mortgage in their own name.

This might sound like a hassle-free deal for both parties – and it can be. But there are risks that come with the benefits. Here, we'll explain how “subject to” deals work, where the risks lie, when it can make sense for buyer and seller, and how to protect yourself.

‘Subject to’ real estate transaction meaning

With a subject-to real estate transaction, the buyer receives ownership of a property while the current mortgage on the property is left in the seller’s name. The deed transfers to the buyer, but the financing remains the same. In basic terms, the buyer promises to keep making the monthly payments on the seller’s mortgage even though the lender hasn’t approved the buyer.

It’s important to understand that since the loan remains in the seller’s name, he or she remains legally responsible for the payments. If the buyer stops making them, it’s the seller who risks going into foreclosure proceedings and having their credit negatively impacted. This is why the real estate purchase agreement between buyer and seller in a “subject to” transaction is very important.

You might be asking why anyone would risk this type of arrangement. But there are times when these deals can make a lot of sense. “Subject to” transactions are often the go-to method when sellers need a speedy sale, for instance when they are facing foreclosure. For their part, buyers are often attracted to these deals when they can’t or don’t want to go through the mortgage qualification process.

‘Subject to’ vs. mortgage assumption

Don’t confuse “subject to” transactions with mortgage assumptions. They’re similar, but different in a very crucial way. In a mortgage assumption, the buyer formally takes over the seller’s loan, with the lender’s approval. This means that the buyer’s name is now on the loan and they are legally responsible for making the payments. If they don’t, they risk foreclosure, not the seller, who is released from liability.

Not all mortgages can be assumed. For instance conventional loans are usually not assumable, but certain government-backed loans – VA, FHA, USDA – are.

In a “subject to” mortgage agreement, the lender isn’t a party in the deal. The loan never changes hands and the seller remains liable for the payments, whether the buyer makes them or not. One thing to know is that most mortgages include a due-on-sale clause. This allows the lender to demand the loan be paid in full if the property transfers to a new owner. They rarely enforce this, but the right exists.

Types of ‘subject to’ real estate deals

Not all “subject to” real estate deals are the same. They come in a few common, but different, types.

‘Subject to’ existing mortgage

This is the most straightforward version. Here, the buyer receives the title to the property and begins making payments on the seller’s mortgage without formal assumption. No changes take place to the original loan note and there is no lender approval.

‘Subject to’ with seller financing

If the original mortgage doesn’t cover the full agreed-upon sales price, the seller may carry a second mortgage to bridge the difference. Here. the buyer pays the original mortgage payments, plus the payments on the seller-financed second mortgage.

‘Subject to’ with wraparound mortgage

A wrap-around mortgage is where the buyer pays the monthly mortgage payments to the seller directly, who then pays the mortgage. Sometimes the payments are more than the monthly payments, so the sales price is covered. This is the riskiest option for the buyer since they are relying on the seller to make the payments to the lender on time and consistently.

How a ‘subject to’ real estate transaction works

As with traditionally financed real estate deals, every transaction has its nuances. But most “subject to” real estate deals follow this general structure:

• The buyer and seller come to an agreement. A price is negotiated between buyer and seller, including how existing arrears will be handled, if they exist and whether there needs to be any additional financing, such as a second. These arrangements may be private and/or include lawyers and official paperwork.
• The home’s deed is transferred to the buyer. Ownership of the home changes hands and the buyer gets legal title. The deed transfer is when the official deal is made.
• The mortgage lender isn’t involved during the process. Since the buyer isn’t applying for a new mortgage, there’s no application, no underwriting, no down payment, and no credit check. That said, a transfer can trigger the due-on-sale clause and the lender could accelerate the loan.
• The buyer begins making payments. The buyer now starts paying the existing mortgage, property taxes, homeowners insurance and any other financing created in the deal.

Pros and cons of ‘subject to’ offers for buyers

“Subject to” real estate deals can offer some great benefits for buyers, but they do come with risks. Here are some pros and cons.

Pros

Easier purchase process. Because a buyer avoids the mortgage approval process, they avoid a lot of paperwork, financial scrutiny, and the loan underwriting process.

Lower up-front costs. There are no lender fees and often no or very little down payment. That means buyers typically need to bring less cash to the table.

Possibly a lower locked-in rate. If the seller’s existing mortgage was taken out in a time of lower interest rates, the buyer effectively gets a below-market rate on the mortgage.

Faster closing process. Closings on “subject to” real estate deals can be quicker since there are fewer parties involved.

Quick home equity or income potential. Because the entire purchase process is faster, the potential to quickly resell or rent out the property exists. This gives investors faster access to cash flow or gains.

Cons

Potential trigger of the due-on-sale clause. If the lender discovers the transfer, they have the right to enforce their due-on-sale clause, which would make the loan payable in full. Buyers should have a plan for that scenario.

Risk of foreclosure. Missed payments can still lead to foreclosure, despite any side agreement between buyer and seller.

Home insurance challenges. Arranging homeowners insurance in the buyer’s name can sometimes be tricky since the loan remains in the seller’s name.

Limited legal protections. If the documentation is not properly carried out regarding property rights, it can leave buyers with difficult legal situations and few remedies.

Pros and cons of ‘subject to’ offers for sellers

While sellers can gain speed and ease of a sale, they also expose themselves to some ongoing risks with a “subject to” deal.

Pros

Possible prevention of foreclosure. For sellers about to face foreclosure, a buyer coming in and picking up the mortgage payments can save the day.

Quick home sale, helpful for cash needs. “Subject to” buyers often close fast, which help families relocating or dealing with urgent financial needs.

No need to make repairs. “Subject to” deals are often as is, which saves time and money, and can be the difference between getting stuck fixing up a property and moving on.

No closing costs. With no new lender involved, sellers often avoid traditional seller-paid closing costs.

Cons

Legal liability of the loan, including credit score risk. Because the seller remains legally responsible for the loan, if the buyer defaults on the mortgage, the seller’s credit score can be harmed.

Possible difficulties financing other properties. Qualifying for a new loan can be more difficult since the current mortgage still counts toward the seller’s debt-to-income ratio.

Risk of mortgage acceleration clause enforcement. The seller could face a demand for full repayment or potential foreclosure if the lender enforces the acceleration clause after a title transfer.

Limited control. The seller has little say in how the property is managed, so if the buyer mismanages it, the seller could be affected.

Is a ‘subject to’ real estate deal right for you?

“Subject to” real estate deals aren’t for every buyer or seller in any situation. They tend to be best suited to certain situations.

For instance, if a buyer is rebuilding their financial or credit profile and is unlikely to qualify for a home loan, a subject-to sale might help them realize homeownership. Or, in a high-interest rate environment, a buyer could “inherit” a seller’s low interest rate, saving thousands.

For sellers, a “subject to” sale could help them avoid foreclosure or bankruptcy with a buyer who can take over their mortgage payments immediately. And for both buyers and sellers who want less paperwork and a sale with fewer third parties involved, a “subject to” deal might be attractive.

Tips for subject-to real estate transactions

Just because subject-to real estate deals are less complex doesn’t mean navigating them is necessarily easy. Here are some tips for both buyers and sellers for success.

Know where to look. Finding a house with sellers who need or want a fast sale because of financial pressures is a common tactic. Finding preforeclosure properties is not as easy as finding homes for sale, but it is possible through online directories like https://www.preforeclosure.com/ and public records.

Understand the rules and the paperwork. State property laws vary, as do mortgage documents. Look for the due-on-sale clause and any prepayment penalties or escrow requirements for the seller’s mortgage and make sure you understand everything before moving forward.

Hire a real estate attorney. Hiring a qualified real estate attorney to draft the sales contract, deed, disclosures and any seller-finance documentation is crucial to reduce risks to both parties.

Vet counterparties. Sellers should verify the buyer’s ability to make payments and credit history. Buyers should confirm where the seller stands with regards to arrears, liens, and code violations.

Evaluate the property and the deal structure. Don’t speed past inspecting the property, estimating repair costs, and checking rental comps if the plan is to rent the home.

Document everything. Retain detailed records of every payment, tax, insurance and repair expense.

The bottom line: Do your research before agreeing to a ‘subject to’ transaction

“Subject to” real estate deals often come with many advantages, such as a faster sale, no mortgage qualification, lower up-front costs, and much less paperwork. However, risks run high as well. Lenders enacting acceleration clauses and demanding the loan be paid off immediately, buyers unable to keep up payments, and other potential issues exist.

For these reasons it’s wise to consider all your options when buying or selling a home. For those who prefer the peace of mind of a more conventional financing, speak to a Rocket Mortgage Home Loan Expert, who can show you all your options.