If you’re a newbie real estate investor, you’re going to face challenges. A pretty universal challenge is finding the money to get started and getting access to credit. Traditional bank mortgage financing may offer lower interest rates, but you’ll likely need a sizable down payment on hand to qualify. If this is a challenge you are currently facing, alternative financing strategies could help you get started. Here is some information on two such methods, Seller Financing and Subject To deals.
Seller financing can be used when the seller no longer has a mortgage on the property, and the buyer either can’t get a traditional mortgage or doesn’t want one. The buyer can request that the seller provides financing directly to them. If the seller agrees, the buyer will typically sign a promissory note to the seller defining the loan conditions such as interest rate, repayment schedule, and consequences of default. The seller retains the deed to the property until the property is paid in full. The advantage for both is that the sale can proceed quickly. The real estate investor can start renovating or renting the property immediately, and the seller can sell their property as-is, and start receiving monthly payments. A seller is more likely to agree to seller financing if they are motivated to sell or in financial distress. An example could be someone that recently inherited a property, and would need to do major renovations before selling it.
Purchase Subject To (Existing Loan)
This financing method assumes that the seller has an existing mortgage on the property, and the buyer either can’t get a traditional mortgage or doesn’t want one. In this case, the buyer receives the deed to the property and takes over the seller’s existing mortgage payments. The advantage to the seller is that, if they were in a distressed situation, they will get quick relief once the buyer starts making the mortgage payments. The advantage to the buyer is a quick purchase and avoiding loan origination expenses.
It is important to clarify that most, if not all, mortgage lenders include a “due on sale” clause in their mortgage contracts. This clause requires that, when a property owner sells or transfers their interest in the mortgaged property, the mortgage must be satisfied (paid off and closed).
So how can this work? In an ideal world, things are done above board, and the seller’s mortgage lender agrees that the buyer can take over the loan repayment. For the mortgage lender to agree, there must be strong arguments why this is in the lender’s interest. From the lender’s perspective, they may make less money on a new mortgage compared to the existing mortgage with a higher interest rate. A homeowner may be underwater on their loan or the home might be in poor condition, and the lender may consider how much they might recoup in the case of foreclosure and subsequent short sale.
A not recommended version of the Subject To strategy is relying on a lender not enforcing the “due on sale” clause. For the same reasons as above, a lender may not look too closely as long as they are receiving mortgage payments on time. There is, however, a significant risk in this strategy as the lender can call in their loan at any time, leaving you without an investment property and the seller in potentially great distress.
A Final Word
For both Seller Financing and Subject To financing deals, both buyer and seller must consult a qualified real estate attorney to ensure that the agreement between them manages their respective risks and provides them with adequate protection.