Subject to - am I paranoid, or ....?

Question

Every time I read about the strategy of assuming a non-assumable mortgage alarms go off in my head. I have read the whole philosophy that banks would rather have a paying customer than foreclose. And this little voice whispers in my head "for now. They are just biding their time". What happens when the combination of appreciation and higher interest rates combine to make it profitable to call in those loans? Does that bank president who you (you the generic investor) made look bad during the recent past by stealing properties for pennies on the dollar have any incentive to cut you a break? Or does he pursue the profit with a vengeance and put the screws to you? Bankers don't do things to protect us, they are protecting their profits. Those due on sale clauses were put there for a reason, so that low interest loans would not be perpetuated by a sale. And now interest rates are starting to rise, and probably will continue to rise. Will banks continue to ignore sales? Forever, or just for a little longer?

Yes, I am on the cautious side, but am I missing something or is this strategy just the replacement for no money down and gamble the wad?

Don Konipol · Answer

@Walt Payne , technically when purchasing a property "subject to" the existing mortgage you are not assuming the mortgage.  Historically, the percentage of loans called due because of deed transfers is very low.  But that being said, some of your concerns are justified.  High interest rates will increase the incentive for lenders to enforce due on sale provisions of low interest loans.

We are dealing here with probabilities, not absolutes.  Lenders foreclosing on residential properties face a variety of obstacles.  Most lenders would err on the side of caution and even if they would initiate foreclosure would do so following the guidelines relevant to when the loan was made - that is residential consumer purpose ( this is assuming the property is residential and existing note was made to an owner occupant or for consumer purpose).

So this adds 6 months to any existing state foreclosure proceedings. The lender now has three choices (1) continue accepting payments as per original note (2) negotiate modification of interest rate with property owner (3) lose interest payments for the one plus years it takes to foreclose.

Even in the worst case, the property owner would have 9 plus months to find a solution, either sell the property, refinance, or take on a partner.  And while the profitability of the investment will suffer, it won't be the total disaster people seem to anticipate.

Please understand this; if done correctly with full disclosures between buyer and seller, there is nothing illegal, immoral, underhanded or unethical about purchasing a property subject to an existing mortgage. No lender, deed of trust or any other party can stop this type of transaction; the lender merely has the right to call the loan due if this type of transaction occurs.

Walt Payne · Answer

Bill Gulley Thank you for the detailed explanation. So, as the old joke goes "just because I'm paranoid (for some incorrect reasons) doesn't mean they aren't out to get me".

Subject to is not a strategy I would have considered at this point, but I am investigating ways to expand in the future. I currently am holding very little debt so it should be possible to use it sparingly with a portfolio loan as a backup plan.

Bill Gulley · Answer

@Walt Payne  I agree with Don in his last paragraph, bits elsewhere but not entirely in this case, which is rare.

You have a very good little voice in your ear.

Calling notes is rather regional and local, it also depends on the bank or lender.

The DOS clause was adopted during a period of rising rates and assuming underlying mortgages created an interest rate risk and that was the initial reason and intent of the St. Germaine Act.

Those that believe all a bank wants is the interest and that they will continue with a loan if payments are made as some profit motive are misguided about or don't understand mortgage banking. The only interest earned on a mortgage is only on those notes held in portfolio by a bank or lender, most all residential loans are sold in the secondary market.

Notes are securitized in the secondary, bonds are issued that generate funds.  Funds do not stay in a residential loan from a bank's vault, they may fund at closing, but those funds are replaced when that loan is sold. The lender no longer receives interest on that loan, it's off the books!

What the lender may do is retain the servicing rights and they receive a slice of the interest as a servicing fee. That fee remains constant, that lender's servicing fee doesn't rise or fall with interest rates.

To retain servicing that servicer enters into servicing agreements, they are required to follow the terms and conditions of the mortgage or deed of trust, including the alienation clause. A servicer may be required to repurchase a note if they fail to abide by servicing terms or it's found that the mortgage was not meeting the conditions or requirements relating to the sale of that note.

Selling subject to the mortgage is a violation of the security agreement under the alienation clause, commonly called the due on sale clause.

St. Germaine actually took care of several issues by curing the interest rate risk matter of rising rates. Not only were rates secured in portfolio loans it also stabilized the rate of blocks of loans securitized by bonds.

The Act also accomplished aspects of curing clogging title in the event of foreclosure.  Drum roll please, may I direct your attention to the lease provisions contained in the Act. Any lease greater than three years is a violation of the alienation clause. Now, for all those who want to insist that it's all about interest rates, please explain how a 4 or 5 year lease effects interest being paid! It doesn't! What is does is that a long term lease clogs title with leasehold interests. It complicates the foreclosure process, not to the point that a lender can't secure the collateral, but it can and does add time and administrative expense.  It also crosses the line of owner-occupied property and being a rental property. Short term leases are acceptable as the ability to lease is a fundamental right of an owner and after a loan is seasoned, the status of occupancy is much less critical, the rate of default and related issues are diminished, such becomes rather insignificant.

All lenders have a written loan policy and guidelines. These guidelines are adopted by the board of directors or, if none, management and by regulatory rule. Servicers will have written servicing guidelines.

There are other players involved, everything that goes on in any bank or insured lending institution is not just up to the whims of a bank president or some senior officer. There are regulatory requirements that guidelines be followed, lenders have contractual obligations with other lenders, mortgage wholesale banking operations, mortgage servicers, syndicators, bond holders and stockholders. Failing to comply with administrative requirements of lending administration can have consequences.

So, for a portfolio loan, the interest rate of loans can be an issue in interest rate risk management, but the alienation of ownership interests is not the only issue. In residential loans sold, interest rates are irrelevant but the contractual obligations and regulatory requirements still remain for any servicer. Technically, if a servicer has knowledge of an owner conveying any interest in violation of the trust agreement they would be in violation of their contractual obligations and oversight required by regulatory authorities.

Bank of America here, under this regional managerial area, will call any loan due if they find there is any breach of the security agreement. No exceptions, they are strict, you will get a notice of default and a demand to cure. You will have the loan accelerated to maturity. Now, the time and how quickly they act will vary. Wells Fargo and Citi are in the same boat here.

Loans are identified with "exceptions" those loans may have different issues but they are rather the black sheep of the heard. They may be loans slotted by performance, with exceptions, slow pay, delinquent, default, non-performing or performing. These loans may be retained and serviced, but to a point depending on the status. There is no requirement to call a note that has exceptions or in any category, but at a point it becomes an issue of prudent management. Some lenders may take a loan identified with issues and retain that loan in portfolio.

Now reality, There are many servicers that are driven by other factors to accelerate a note, there are others that assume the potential risks from all angles and continue service a loan. Has nothing to do with interest being earned or a service fee being retained.

One aspect is just human nature, most people don't generally add to their work load, they avoid conflict, they avoid complicating matters, if there is no real threat of loss, no real expectation of the loan going bad or unpaid, it's very possible that hourly paid clerk will just make a note in the file to CYA themselves, play ignorant and file the matter, doing absolutely nothing.

Loan officers, loans are tracked back to the responsible originator. A portfolio lender will have the originator, loan officer active in the management of his or her portfolio, that officer may learn of some exception and choose to simply manage the matter. If their policy guidelines give them leeway to manage such situations they may do so, if they are required to take action, they probably will. Loan officers do get fired, their pay is tied to their duties and performance, the quality of business. I doubt any officer would be fired over allowing a sub-to to slip by them or any other conveyance matter, but they could be. That's a management call.

Any portfolio manager at any level understands that any block of loans will have exceptions or issues, they know that there will be a percentage of loans that are non-compliant, it's a factor known and accepted as the life of any individual loan can change over time. So, it's no real surprise if they know some loan in servicing was sold or some interest was transferred. Do they want to pull that loan, replace it with another loan to balance out a collateral or security assignment, do they want to take a performing loan and put it the backlog of non-performing loans going to foreclosure? There is not that much thought to the interest earned on a $96,362.86 loan in a $50,000,000 portfolio, that is insignificant!

Getting closer to home, asset managers or portfolio managers may work by region, they may oversee several states or some are just working one state. They are aware of foreclosure laws, they are aware of the steps to go through to squash other claims or liens on a collateralized property. In some areas, it is very expensive to take collateral, in other areas it can be a cake walk. The significance of the perceived threat will be weighed if issues are known and weighed to the threat and risk as a collateral management issue, it's not about getting a $28,50 servicing fee next month on that loan!

So, lets toss aside all these misconceptions about lender's not calling a mortgage due under the due on sale clause because they want the interest! Toss aside thinking no lender will accelerate a loan in a sub-to transaction, they can and do. Toss aside the thinking that you will know which loan might be called or when it will be called, if ever. These are unknown factors or risks in doing a sub-to deal.

If you're going to do sub-to transactions it's best to be prepared for the note being called, be in a position to exit the deal quickly, pay off the mortgage, get it refinanced or sell it for cash to pay off the obligation. If it's not called due on you, all the better, lucky you, move on and enjoy!  :)

Bryan L. · Answer

@Walt Payne  - Based on your overly cautious comments here and your fear of unpermitted non-loadbearing walls, I would suggest that you just sit it all out and not do any investing.  It's too risky for you.

Walt Payne · Answer

I have a number of properties and the money and ability to buy quite a few more. I didn't get in this position by being afraid to act. Nor did I get here through rash acts and blindly following. I question to understand.

Some of my comments that you think are overly cautious are made to inexperienced people who wouldn't know how to bypass the risks. In that case they are better off taking a different course than I might myself take.

Bryan L. · Answer

@Walt Payne  - Hey, you're the one who asked if you're being too paranoid.  And yes, you are.  I'm cautious too, but this is a risky biz.  Get out there and make something happen.

And no, you don't have to do anything my way.  But you will never do anything at all if you are overly concerned about "what-ifs".

Walt Payne · Answer

So if I don't do it your way I should quit?

I have no fear of unpermitted properties whatsoever. I have bought several. In fact the situation allowed me to get additional discounts. I just refuse to bury my huead in the sand and ignore problems and risks. I identify the problem and deal with it.

I asked this question because before engaging in risks it is best to understand them and formulate a strategy that minimizes their effect. That is not done by blindly following others and hoping there isn't a cliff up ahead.

I am sorry if questioning your answers  is offensive to you,  that is just my nature. I will try to remember that in the future.

Walt Payne · Answer

On  the surface that sounds like a solid strategy. Until a second, and third and fourth lendrer draw the same conclusion. And best case scrnario is that interest rates are up. Not a good situation to try selling.

Bryan L. · Answer

@Walt Payne  - So what happens when one buys a house sub2 and the loan gets called due (or foreclosed)?  If you bought right and only bought houses with equity, then put it on the market and sell it conventionally, get the money, and pay off the loan.

Subject to - am I paranoid, or ....?

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