Subject To real estate explained step by step by one of the leading experts on the subject, Freedom Mentor's Brian Busch. Discover what a Subject To is, why a seller might sell Subject To, how to buy a house Subject To and most importantly, the 3 best ways to make money with Subject To real estate.
What is Subject To?
I've been a real estate investor for over twenty years and worked with Phil for the last fifteen. We've successfully closed hundreds of Subject To deals in nearly all 50 states and have seen everything you can see with Subject To - at least twice. But you may not be familiar with Subject To, so what exactly is it?
In a typical sale, a seller likely owes a mortgage against their property. When they want to sell the property, regardless of how they sell, they will find a buyer. When they do, the buyer will either get a loan or pay cash. Either way, at closing that buyer's money is going to pay off the seller's underlying note.
But there's an alternative and that is Subject To, whereby you buy the property but leave the loan in place. This strategy is tremendously underutilized and most agents and many title companies have very little to no experience with it even though it’s been around for decades. In fact, if you'll look at the HUD 1, line 503, or on the Closing Disclosure section N.03, you'll see a line that says "existing loans taken Subject To". This has been around literally for decades, so it's possible to do even though many are not familiar with it. It's an alternative, where title will transfer but not the loan. The loan is going to remain in the seller's name. So let's dig deeper into this creative financing strategy.
Why Would a Seller Sell Subject To?
Why would someone deed their property to a buyer, leave the loan with their name on it, and just hope that that buyer will make the payment? Well, the answer is sellers wouldn't do that unless they didn't have better options. Some sellers unfortunately are in a position where they must sell. Maybe they've lost a job, or they have a job opportunity and need to get moved quickly. They might be going through divorce or have a sick family member they need to move closer to. Perhaps they've inherited the property. Whatever the reason, they need to sell fast.
Often these sellers have limited options and may already be behind on payments. They may not have equity, or maybe they need to bring money to closing and that's not an option for them. Some might need cash just to get moved. Others are looking to avoid a short sale, which isn't short. They might be facing foreclosure and a deficiency judgment. Either way, they're stuck between a rock and a hard place, and they need options. Some people just need to get moved on with life and Subject To can be an alternative to a traditional sale that allows them to do that.
Benefits of Subject To
What are the benefits to subject to for sellers? Again, they get to avoid a loss and in most cases they can get moved quickly and to a better chapter of life. But what about for buyers? Well, Subject To can be a wonderful opportunity to become a homeowner, especially when increasing rates make it harder to find affordable housing. And if a buyer isn’t well positioned for a loan to begin with, maybe they have past credit issues, medical problems still affecting their credit, or don't have W2 income, subject to can be provide a solution. Just imagine if right now you were able to get an interest rate significantly lower than the prevailing rate and being able to do so without qualifying with a bank, even if you have bad credit. All this is possible with Subject To.
What about for lenders? Oftentimes lenders are just trying to avoid the cost of collections and foreclosure. If they can get a reinstatement, they don't have reserves tied up and they can get their performing loan back on the books and moving forward. So it's beneficial to lenders as well.
For investors, obviously, if you're able to provide the expertise needed to structure these win-win solutions, you can generate quick profits and you can make even more over time. So let's dig into how Subject To works.
How to Buy Subject To Step By Step
Step1: Connect with the Seller
As investors, buying Subject To starts with connecting with the seller, not agents. We're not looking for properties on MLS because in most cases, agents don't have experience with Subject To. As such, they're going to be a roadblock to the transaction. So you want to work directly with sellers and at Freedom Mentor we've mastered this art.
Step 2: Review the Seller’s Situation
After connecting with the seller, the next step is to review the seller situation. You need to review all their details including:
- Mortgages and balances of those mortgages.
- Loan terms and if they have a reinstatement that's needed.
- Liens against the property.
After reviewing the seller situation, you need to compare all the numbers to the current value, the after-repair value, and look at the rents in comparison to payments.
Step 3: Contract
If the numbers work, then you can move into the contract phase, making sure that you have paperwork that protects your position and allows you ample time to complete your due diligence. Diligence is key in a Subject To purchase because you're taking over on someone else's loan, and you need to make sure you're clear on what you're taking over. You need to make sure you get a payoff and that they didn't use any loan programs or other things when they purchased that they might not have mentioned. You want clarity on the numbers and clarity on title.
Now, title is an important piece because if there are title problems and you don't learn about them before you buy, you're going to be stuck with them when you try to resell. And that can cost you thousands of dollars or even the deal, especially if you need to track down a seller or heirs or other lien holders later on. So you absolutely want to complete a title search. Check out Phil's training, the Investor's Guide to Real Estate Title. It'll give you all the details you need to stay protected. If all these items have checked out, including of course an inspection, then you're ready to move forward to closing.
Step 4: Closing with Title
Now, closing might take place with a title company or a closing attorney. And it may need to get creative depending on the situation. As you can imagine, after over two decades of these, we have run into every conceivable roadblock possible, and we've learned how to get around them. If you get to this point, you’ve closed on the deal. You are now the owner of a property, and you didn't have to qualify with a bank.
3 Ways to Make Money with a Subject To Deal
Strategy #1 - Rental
Making money with a Subject To purchase really begins before you close because you want a clear plan on how you will make money with the property, often referred to as your exit strategy. And one of the most common strategies is a standard rental. It's been around for a very long time and it will be around for a very long time. The key in my experience is management. If you have solid management, you can make a property profitable. If you don't have solid management, that's when you get into the nightmares that come with rentals. Now a portfolio or building a holding of rentals can obviously help you create wealth. It's been used by millionaires more than any other vehicle to create wealth. Standard rental is always an option, but there are others and that's what we want to look at next.
Strategy #2 -Rent to Own or Lease Option
Rent to own, also known as a lease option, is when you lease the property to a tenant who's purchased the option to buy the property from you within a given timeframe at a set price. Now these can be very quick and very profitable for you. For some wisdom on this, check out Phil's video How to Sell Your House Rent to Own. He'll go through all the details. But here’s an example of a Subject To deal with a lease option.
Connect with the Seller
Our apprentices in the Midwest were approached by a seller that wanted to downsize. She owed $123,000 on the property and was three months behind on her monthly payments of $890. She was a motivated seller with limited options who just wanted to get out from under the property and break even. The magic words we love to hear! And on top of that, she was willing to sell Subject To.
Review the Seller’s Situation
Our apprentices knew that the property could rent for $1200 a month. They learned it was an FHA loan with a 4.375% rate fixed and that there would be no balloon due. So they moved forward with the contract.
They got the contract at $123,000 with zero down, allowing the seller 60 days to get moved out. Then they proceeded with their due diligence. That's when they ordered a payoff and learned that the seller actually owed $126,000, but the deal still made sense. However, when they did a title search, they learned there was a second large loan of $50,000. It was a HUD assistance program that the seller had agreed to several years prior because there were no monthly payments and had subsequently forgotten about. That brought the total debt to $176,000. With these new numbers, they weren’t sure if the deal was going to make sense, but when they did the comps, they realized there was a possibility it could work. They didn't think that a short sale would make sense, so they decided to market the property and put it up for lease option.
First Lease Option Terms: Our apprentices found a buyer that had $10,000 upfront and could afford $1,375 a month and wanted a two-year option and $194,000. Out of that $10,000 upfront, they would have to reinstate the loan, there were some improvements that needed to be done, and they needed to thoroughly clean the property because the seller was a smoker. They ran the ozone machine and were able to get the property in great shape.
Closing with Title
They closed on the deal and put the tenant buyer in with a $10,000 up front. Out of that $10,000:
- $3,000 went towards reinstating.
- $3,000 was kept for reserves.
- $,2000 went into the improvements needed.
- $ 3,000 went in their pocket upfront.
Not bad for their first deal right up front. After two years, the tenant buyer did not exercise their option. So all the payments that were made, which were creating $485/m in positive cash flow, added to the money they were bringing in. (With a tenant buyer the operating expenses are passed to the tenant buyer, so our apprentices were able to capture all $485/m).
Second Lease Option Terms: Since the first tenant buyer did not exercise their option, they decided to find another tenant buyer. This time they found a tenant buyer willing to do $6,500 upfront and $1525 a month. However, the buyer wanted a four-year option, and they also wanted a rent credit. So our apprentice agreed to do $150 a month rent credit, which meant that for every month that that tenant paid on time, they would be credited $150 if they exercised their option. Now in this case, the tenant buyer did exercise their option in just under two years.
In the meantime, our apprentices put about $4,000 into their pocket because $500 of that was treated as a security deposit. And about $2000 had to go into cleaning up the property and doing some other improvements between the two tenants which means they put about $4,000 additionally. And because they leased the property for about 20 months before exercising their option, all in all, with the changes in the payment because obviously taxes and insurance go up over time, they did bring in a higher payment. They ended up bringing in a total of about $18,000 in cashflow in just under four-year period.
- $3000 at the beginning of the deal
- $4,000 in the second round
- $18,000 total cashflow
They were cashflow positive $25,000, in addition to the typical benefits you have from taxes, appreciation and depreciation.
Total Profit: The property sold for $207,000 which gave them an additional $32,000 at closing, making the total profit from this deal $57,000.
- The seller benefited because her payments were made on time. The loan was paid in full.
- The buyer benefited because all the improvements that they had made to the property were theirs to keep. It appraised well above what they needed, and they were happy.
- The lender was able to be reinstated and had a performing loan at a time when a lot of loans weren't performing.
- For our apprentice, the investor, again, they made over net $57,000 on their very first deal.
You can see that Subject To and lease option can be great win and very profitable.
Strategy #3 - Rehab and Retail
Another way we love making money with a Subject To purchase is rehab and retail. Let's look at an example.
Connect with the Seller
Our apprentice Scott had done several deals with us and was therefore comfortable taking on a property that needed some work. The sellers were empty nesters that were looking to move out of state. The property was dated and after 20 years, all they saw were the repairs needed. Because they wanted to buy a new property, they wanted a fair amount for this one, more than a fast cash offer would provide. And due to the condition, our apprentice knew that Subject To was really the only fit and it was indeed a fit for the seller if they could qualify for a new loan.
Review the Seller’s Situation
Since we've developed strategies to overcome these kinds of obstacles, our apprentice was confident moving forward. He learned that the seller owed $137,000 on the property with a conventional loan at 5% and a note at $1561/month that was current. Scott also knew the rent range was well higher than the payment. He had a plan B if needed, but plan A was to do the minor repairs needed and resell the property.
Scott negotiated a contract at $235,000.
- From that $137,00 would be Subject To the existing financing.
- $3,000 would be paid cash to the seller at closing.
- $95,000 would be carried back by the seller's owner finance.
Now, a key piece to this deal was that the sellers needed flexibility in the closing. They needed to make sure that the buyer wouldn't rush them out of their property, but once they found their new property, they wanted to make sure that the buyer could close quickly. And our apprentice was willing to do that because Subject To makes that all the easier. After they got it under contract, Scott began the due diligence phase. Sure enough, the payoff was indeed $137,000, and fortunately there were no surprises with the deal. It just required patience. That gave our apprentice time to do the diligence inspection, get clarity on condition, and be confident in the comps because he wouldn't be able to market the property prior to closing.
Closing with Title
Scott gained the confidence he needed, the seller's found a property and he was able to close creatively within the timeframe agreed and that allowed the seller to obtain their new loan. Once he had the property, he put the next several weeks into improving the property, investing about $5,700 into improvements, but that went a long way. Again, his goal was not to make the property new or over renovate it, but simply to get it solid. In doing so, he was able to list the property a little higher than he originally thought at $299,900. That drove a lot of buyers in the door, and he ended up with a multiple offer situation and agreed at $305,000.
- $305,000 was a huge win for the buyer because they'd been searching for a home and were trying to use a grant program that allowed them to become first time home buyers. They were more than happy that he selected their offer.
- The seller's note was paid in just under three months. They received all their payments during the Subject To and their payment in full.
- Our apprentice made just over $41,000 in net profit in just under three months. So it was a win-win for Scott and his seller.
Every Successful Creative Real Estate Investor Has a Mentor
If you're wanting to take real estate investing to the next level, then do what I did many years ago and find the right mentor. I spent eight years trying to figure all this out on my own with mediocre results. But when I was selected to become an apprentice of Phil's, worked with the Freedom Mentor Team to gain the training, the guidance, the mentoring that I desperately needed, that's when my life changed and I accomplished more in 18 months than I had in the previous eight years, and I haven't looked back since. Except to share from all my tough lessons and help now hundreds of apprentices become highly profitable real estate investors, the best in their markets that are truly enjoying the success that is uniquely possible in real estate with the right coaching. If you are ready to take a step towards a brighter financial future for you and your family, like I did, apply to our Apprentice Program here: Freedom Mentor Apprentice Program