Discover the 3 biggest pitfalls of Subject To investing. These 3 issues can completely destroy a Subject To investment and they are rarely, if ever, mentioned by anyone. However, if you want to be successful investing in Subject To deals, it’s essential that you overcome these 3 Subject To challenges and this training will show you how.
We've closed hundreds of Subject To deals in nearly all 50 states and seen just about everything that can go wrong, including when they catch fire and burn down! But if you're new to this subject, check out Subject To Real Estate Explained Step by Step. In that detailed training, you'll learn what Subject To is, why a seller might sell Subject To, how to buy a house Subject To, and the 3 best ways to make money with Subject To real estate. Now, let's get into the pitfalls.
Subject To Pitfall #1 – Bad Deals
The first big pitfall to Subject To investing is doing a bad deal. You've talked with a seller; you've made your offers. Perhaps the only fit is Subject To and while it would solve the seller's problem, is it going to make you money? Here are some of the questions we teach everyone we mentor to ask of every Subject To deal:
Equity: Have you first and foremost checked to see what the value of the property is versus what's owed against it? Have you determined that there is equity in the deal, and that you have room to make a profit?
Loans: Have you checked out the loans against the property? Besides perhaps the purchase money mortgage, is there a second? For example, a HELOC (Home Equity Line of Credit) the seller could still borrow against, which you certainly wouldn't want to leave active. You also need to check for occupancy requirements on any of the loans against the property that might not be conducive to doing Subject To.
Reinstatement Payments: Have you looked to see that the payments are current or is there perhaps a large balance due that requires a reinstatement that might take away from some of the profits and equity that you thought you had?
Title: Have you done a thorough title search to understand any loans and liens and judgements against title? Have you looked at the chain of title in that title search to ensure there's no marriage or death or divorce or any other complications that might not allow you to clearly resell the property later on?
Timing: Have you looked at your overall timing to ensure that you put enough into your diligence? You don’t want to be rushed into a purchase and miss something, including balloons. Is there a loan that has a balloon; a lump sum that's going to be due? Maybe it was a 30-year note, but it has a five-year balloon payment due, and you need to come up with that full balance. You want to be aware of that and not get caught off guard later on. So you need to make sure the timing makes sense.
Management: Do you have a management plan in place? Are you going to hire a property manager or do it yourself? And if so, do you have a system to manage in place? It can be easy to put someone in a property, but getting them out can be a nightmare, and you want to make sure that you have a proactive management plan in place to avoid headaches.
Numbers: Do your numbers make sense? Normally, when we're going into a Subject To deal, we're not positioned to immediately resell. As such, we need to consider whether there will be cashflow. Are we going to have enough equity to be profitable at some point? And how long will that be? Perhaps the deal's actually upside down or requires a short sale. Subject To wouldn't make sense at that point. In some cases, we might be able to retail after doing some rehab to the property, so that might be a plan as well.
Exit Strategy: In other words, do you have an exit strategy or plan to take your profit on the deal? You want to make sure that you have a plan. Is it going to be short-term? Is it going to be long-term? Probably the biggest mistake I see investors make is being so eager to get into the deal, that they they don't have an exit strategy. And they find out after they own the problem that they're going to lose money and that they need to get out from under this. That's not good for the investor or the seller, especially if the investor were to walk away.
How to Avoid a Bad Subject To Deal
So you need to look at all these to make sure you don’t have a bad deal. If you don't thoroughly look at each of these pieces, you might find yourself in a bad position. And sometimes it may just boil down to lack of experience. Maybe you know some of this, but you know just enough to be dangerous. We have an experienced team that closes these deals every month and has mastered Subject To investing. And we can help you navigate every aspect of a Subject To deal so you can avoid this pitfall. Let's look at the next big pitfall.
Subject To Pitfall #2: Due-On-Sale Clause
The next big pitfall to Subject To investing is the due-on-sale clause, which allows lenders to call the loan due in full if title transfers. And in Subject To, title is transferring from the seller to the new buyer. Back in the 1970s and 80s, when interest rates were high (7% to 18%), buyers were looking for ways to save money when they purchased a property. And if the seller had an existing loan with a lower interest rate, they simply took over on that loan. Banks had no way of stopping them, so they sought after language to protect themselves, hence the birth of the do-on-sale clause.
Exceptions to Due-On-Sale
The Garn St. Germaine Act of 1982 was legislation that made some exceptions for due-on-sale:
- Death of the borrower
- If the borrower is using a living trust
- Federally insured loans (FHA, VA, USDA)
So while this language has been around for nearly 50 years, for the past couple decades low interest rates have kept this from being much of a concern for most investors. Banks simply haven't been pursuing due-on-sale in any kind of aggressive way. However, with the interest rate increase we've been seeing, they may pursue it, and you need to be prepared for this pitfall. If they call the loan due, you will have a limited time to either get new financing or sell the property to protect your profit position.
Ways to Navigate Due-On-Sale
Lease Option: At Freedom Mentor we have developed proprietary techniques to allow our apprentices to overcome these challenges outside of the normal solutions that many investors pursue, one of which is lease option. In a lease option, title is not transferring to the new buyer so do-on-sale is not a concern. But lease options have downsides because you're not getting title. You don't have the same control over the deal, and you need the seller's cooperation down the road to realize your profit. If you want to learn more about lease options, check out our training called Creative Financing Comparison to learn more.
Wrap Around Mortgage: Another solution investors try to use is a wraparound mortgage, putting a new mortgage around the existing. However, that doesn't overcome the due-on-sale so it's rarely used.
Trust: Due to the Garn St. Germain Act, the trust has been a common solution, although it’s more complicated and expensive. It also has some downsides if you live in a state where title (the deed), moves over to the trustee rather than the trust, meaning you will have to give a measure of control over to the trustee. And there's another downside to using a trust, which takes us into our third big pitfall.
Subject To Pitfall #3 - Insurance
The third big pitfall to Subject To investing is insurance. Whether using a trust or not, when title transfers from the seller to a new buyer, the existing insurance policy is void and will not cover any loss. Now, you can cancel that policy, but when you do the lender is informed. Once the lender sees that they're not protected, they will put a forced insurance policy in place, which is a lot more expensive. And when you obtain new coverage in the name of the new buyer, if you send that to the lender and it doesn't match their borrower, they will see they're not protected and put a force policy in place. They're also likely to start digging in to find out what's going on with title. So the solution for a long time has been to have two policies:
- Leave the existing policy in place, which doesn’t cover loss.
- Put a new policy in place that would cover loss, but don't send it to the lender.
That means double the premium which makes it harder to carry a Subject To deal.
Overcome the Challenge of Insurance
To overcome the challenge of insurance we have developed methods that work 99% of the time. These methods have enabled us to do hundreds of Subject To transactions successfully. But the real world test of any method comes down to when you have a problem. We’ve had two apprentices that had properties catch fire and burn to the ground. Thankfully, no one was harmed, and our apprentices were able to take in the insurance funds, satisfy all debts against the property, and in each case net over a hundred thousand in profits. So that has been a real test that we've absolutely passed.
If you have any questions, post a comment below or text FREEDOM to 305-315-8030.
Every Successful Subject To Investor Has a Mentor
Subject To investing is complicated. If you want to avoid the pitfalls and learn to make seemingly impossible deals of all types easy, apply to our mentorship program here: Freedom Mentor Apprentice Program