Buying Foreclosures Subject-to

With the number of foreclosures and upcoming foreclosures, it is important to understand different strategies to profit from them. If you are looking to build a portfolio of properties with a long-term wealth-building strategy, you may want to consider buying foreclosures subject-to the existing financing. This is especially easy with pre-foreclosed homes.

What Does “Subject To” Mean?

Let’s start by explaining what I mean when I say “buy a property subject to”.   Subject to simply means a condition of.  The term subject to in real estate most commonly means buying the house with the current financing staying in place.  You having title is subject to the underlying loan.  Stay with me here, the underlying loan is in the name of the seller and you are not formally assuming the loan.  You have little to no liability to make the payment on that loan but if the loan is not kept current you run the risk of being foreclosed out of the deal by the lender.   This can be confusing so let me go through a common example of when this is used and how it works in the real world.

Real-World Example

Sam and Sandra have been married for several years and bought a house together.  They both sign on the mortgage so the loan shows up on both credit reports and they are both responsible for it.  They get into a big fight over buying a new 3D TV and decide to get a divorce.  In the divorce Sandra will get the house so Sam is ordered to deed his interest in the property.  Sam signs a deed removing him from title but the loan does not change.  Sam is still legally responsible for the mortgage but does not own the house.

Building a Portfolio

I have purchased several houses this way.  The owner simply deeds the property to me and I take over the payments on their loan.  This is a great strategy to build a large portfolio of cash flowing properties.

Here are some advantages to you as an investor:

  • No loan requirements to qualify for.
  • You can own an unlimited number of these.
  • Little to no closing costs.
  • You are farther along the amortization schedule so a larger portion of your payment goes to principal.
  • You can sometimes get a better interest rate since the loan was originated with an owner occupied borrower.  (this may not be true today with dirt cheap mortgage rates)

Here are some advantages to the homeowner:

  • Easy and quick closing.
  • No need to bring cash to closing if they have no equity.
  • Can help reestablish credit when you make their loan current.
  • Avoid problems of owning the house (most common is foreclosure)
  • Some investors will rent the house back to the owner which I don’t recommend but the benefit with this is the owner won’t lose their home.

There is obviously some risk for the homeowner that you won’t make their payment.  If you do a deal like this you better make those payments.  Make their payment before you own mortgage payment.  They trust you and will be putting a large part of their financial lives in your hands so please don’t be irresponsible about it.

A risk to both of you is that the lender calls the note due.  Almost all loans have a clause in the mortgage or deed of trust that if ownership changes they have the right to call the note due.  There are ways to circumvent this clause.  With that being said, even if the lender knows title transferred they will most likely leave you alone as long as you are keeping the loan current.  Think about it… why would a lender call a loan due and turn it into a non-performing loan when they have enough other problems to worry about.  Of course they are going to want a performing loan on their books; in fact they will probably love you for turning a troubled asset into a profitable one.  Not to mention rates are low so if they get the money back they will most likely need to loan it back out at a lower rate or return.

Why would someone ever deed you their house?

Like I mentioned in the benefits section the most common reason a seller would do this is if they are behind on their mortgage payments and do not have enough equity to sell the house.  In this case they don’t have many options.

The way this works is that you would put the house under contract explaining exactly how you plan to close on the house.  After you do your diligence and wait the required amount of time (more on this next month) you will meet for a closing.  They will sign over the house; you will make up all the back payments and start making their mortgage payment.  You can then rent the house, do a lease option or do some other type of owner finance deal with a new buyer.  This can be very profitable for you and can be a very positive experience for the troubled homeowner.

I good Title Company for this type of closing is Mile High Title.

You need to be very careful when you are dealing with a property in foreclosure, especially if you are buying it as an investment.  Next month I will cover how to protect yourself from the Colorado Foreclosure Protection Act and what you must do to comply.