“Subject to” also known as “Sub to” is a term used in real estate transactions where a buyer purchases a property subject to the existing mortgage. This is a non-qualified assumption of the existing loan(s). Sub to is totally legal, and much more common than people know! Subject to is our favorite creative financing method. Banks are happy to get on time payments; and buyers and sellers are happy they don’t have to involve the banks with the hassles and costs of any new bank loans!
When a property is purchased “subject to” existing loans, it means that the buyer acquires the property while leaving the seller’s mortgage (note) in place. A Loan Assumption Addendum is used along with other Addendums like a Seller Finance Addendum. While a mortgage wrap is a financing arrangement where a buyer creates a new mortgage using seller financing by assuming the seller’s existing mortgage, aka subject to.
Here’s a brief summary of how a subject to purchase typically works:
- Agreement: The buyer and seller agree to a purchase price and terms for the property, including the decision to proceed with a subject to transaction. Both parties sign a purchase agreement or contract outlining the details of the sale with a subject to addendum.
- Mortgage Transfer: Instead of paying off the seller’s existing mortgage, the buyer takes over the responsibility for making mortgage payments on behalf of the seller. The buyer does not assume the liability for the loan formally, but rather takes control of the property and continues making payments to the lender.
- Due Diligence: The buyer conducts thorough due diligence to ensure they understand the terms and conditions of the existing loan, including interest rate, repayment schedule, and any associated fees or penalties. They may also review the property’s title to confirm there are no liens or encumbrances.
- Closing and Transfer: At the closing, the buyer and seller complete the necessary paperwork to transfer ownership of the property. The buyer typically pays the agreed-upon purchase price to the seller, and the title is transferred to the buyer.
- Ongoing Mortgage Payments: After the purchase, the buyer assumes responsibility for making timely mortgage payments to the lender, ensuring that the loan remains in good standing. The seller’s name may still be on the mortgage, but the buyer is responsible for making the payments.
Here are the advantages and disadvantages of purchasing a property “subject to” the existing mortgage:
- No Need for New Financing: When purchasing a property “subject to,” the buyer does not need to obtain a new mortgage or financing. This can be beneficial if the buyer does not qualify for a traditional mortgage or prefers not to go through the loan application process. Banks are a hassle and increase costs in a transaction costing the buyer more money which can in turn cost the seller.
- Potentially Favorable Mortgage Terms: By assuming the existing mortgage, the buyer may benefit from more favorable terms, such as a lower interest rate, longer repayment period, or a fixed rate compared to what they could secure with a new mortgage. Currently with high mortgage interest rates Sub to is very popular.
- Avoiding Closing Costs: Since the buyer is not obtaining new financing, they may be able to avoid some of the closing costs associated with obtaining a new mortgage, such as loan origination fees or appraisal costs.
- Immediate Ownership: The buyer gains immediate ownership and possession of the property upon the completion of the purchase transaction, without having to wait for mortgage approval or loan processing.
- Improve credit score and financial opportunities of the seller:
- Timely Mortgage Payments: If the buyer continues making timely mortgage payments on behalf of the seller, it can help maintain a positive payment history. Consistent, on-time payments contribute to building a good credit history and can potentially improve the seller’s credit score over time.
- Reduced Debt-to-Income Ratio: When the buyer takes over the existing mortgage, the seller’s outstanding loan balance is effectively transferred to the buyer. As a result, the seller’s outstanding debt is reduced, which can positively affect their debt-to-income ratio. A lower debt-to-income ratio is generally considered favorable in lending evaluations.
- Potential for New Credit Opportunities: By relieving the seller of the mortgage payment obligation, the seller may have improved cash flow and more financial flexibility. This enhanced financial situation can potentially open up opportunities for the seller to take on new credit, if needed, and responsibly manage additional lines of credit or loans.
- Risk for the Buyer: The buyer assumes the risk of default on the existing mortgage. If the buyer fails to make the mortgage payments, the lender can still foreclose on the property, and the buyer could lose their investment.
- No Control over the Mortgage: Since the mortgage remains in the seller’s name, the buyer has no control over the terms of the existing mortgage. The buyer is dependent on the seller to make timely payments to avoid default or other issues that could negatively impact the buyer.
- Due-on-Sale Clause: Most mortgages contain a due-on-sale clause, which gives the lender the right to accelerate the loan and demand full payment if the property ownership changes. While the due-on-sale clause is rarely enforced, there is a risk that the lender may exercise this option, requiring the buyer to pay off the mortgage or face foreclosure.
- Seller’s Credit and Liabilities: The seller remains legally liable for the mortgage even after the property is sold “subject to.” If the seller fails to make the mortgage payments, it could negatively affect their credit, and it may have consequences for the buyer if the lender pursues remedies against the seller.
- Limited Legal Protection: Purchasing a property “subject to” may offer limited legal protection for the buyer since they are not assuming the mortgage officially. If issues arise with the mortgage or the property’s title, the buyer may have limited recourse or legal remedies compared to traditional mortgage holders.
It’s crucial to consult with a real estate attorney or financial advisor to fully understand the legal and financial implications of purchasing a property “subject to” and to assess whether it is a suitable option based on your specific circumstances.