How can a "subject to" property be sold without paying off the Deed first?
Musician & Real Estate Investor · Edmonds, WA · Member since 2014 · 43 posts · 12 votes
How can a "subject to" property be sold without paying off the Deed first?
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Real Estate Investor · Tucson, AZ · Member since 2015 · 17 posts · 18 votes
11yJeremy,
As you know, real property records in the US are maintained in a recording system. This is different than a registration system (think what we have for cars). You can record anything you want at the recorders, and the recorders only real responsibility is to make sure its signed and filed in the proper place. This is unlike a registration system where the framework dictates what you can and cant do. Try transferring your car title at the DMV while there is still a lien on it for example. The benefits of a recording system include less expensive administration and freedom to contract (also property doesn't lend its self well to registration because its hard to define, changes over time, and doesn't go away. Cars have simple vin numbers.)
Title insurance companies basically sprang up as a market response to our use of a recording system. Since the administrator (recorder) isn't setting any rules people wanted insurance to guarantee that they were buying what they thought they were being sold and lender were secured where they thought they should be: enter title insurance. A title company is not an agent of the recorder and has no interest in the terms of what is recorded. They only care that the docs were signed by the proper parties and sent at the right time to the proper place so they wont be liable for an insurance claim. The responsibility of enforcing a lien is squarely on the shoulders of a lender.
So, say you deliver your executed purchase contract to your favorite title company for closing. In the contract you write that the you will take title 'subject to all liens and encumbrances.' The title company pulls their title commitment and listed on schedule B exceptions will be the 1st position hard money lender from your example. What this is saying is, 'we the title company will give you insurance for everything we normally would (seller has marketable title and can sell to you, the taxes are paid, there aren't any strange easements etc.), but we've notified you that this lien is there and we wont pay you any insurance if they try to collect or make some claim on title.'
So you review the correspond lien docs the title company provided for you as part of their commitment and get a feel for that lender's terms and conditions. Based on what you find, you and the seller make a business decision on if you want to move forward: how big an institution is the lender, will you keep paying the loan, is there a due on sale clause, what is the risk the seller will find out someone different is making the payments, how quickly can you refi or flip it etc etc. I will say briefly that you can mitigate a lot of these risks by using creative structures, but Ill save the details for another time.
So in summary, the title company's job is not to pay off all liens. It is to do what ever you tell it to in the sales contract or escrow instructions. If you accept certain exceptions they will happily give you a limited warranty deed. Its the banks job to enforce the terms of their arrangement, not anyone else's.
43 Replies
- Real Estate Investor · Tucson, AZ · Member since 2015 · 17 posts · 18 votes11y
Jeremy,
As you know, real property records in the US are maintained in a recording system. This is different than a registration system (think what we have for cars). You can record anything you want at the recorders, and the recorders only real responsibility is to make sure its signed and filed in the proper place. This is unlike a registration system where the framework dictates what you can and cant do. Try transferring your car title at the DMV while there is still a lien on it for example. The benefits of a recording system include less expensive administration and freedom to contract (also property doesn't lend its self well to registration because its hard to define, changes over time, and doesn't go away. Cars have simple vin numbers.)
Title insurance companies basically sprang up as a market response to our use of a recording system. Since the administrator (recorder) isn't setting any rules people wanted insurance to guarantee that they were buying what they thought they were being sold and lender were secured where they thought they should be: enter title insurance. A title company is not an agent of the recorder and has no interest in the terms of what is recorded. They only care that the docs were signed by the proper parties and sent at the right time to the proper place so they wont be liable for an insurance claim. The responsibility of enforcing a lien is squarely on the shoulders of a lender.
So, say you deliver your executed purchase contract to your favorite title company for closing. In the contract you write that the you will take title 'subject to all liens and encumbrances.' The title company pulls their title commitment and listed on schedule B exceptions will be the 1st position hard money lender from your example. What this is saying is, 'we the title company will give you insurance for everything we normally would (seller has marketable title and can sell to you, the taxes are paid, there aren't any strange easements etc.), but we've notified you that this lien is there and we wont pay you any insurance if they try to collect or make some claim on title.'
So you review the correspond lien docs the title company provided for you as part of their commitment and get a feel for that lender's terms and conditions. Based on what you find, you and the seller make a business decision on if you want to move forward: how big an institution is the lender, will you keep paying the loan, is there a due on sale clause, what is the risk the seller will find out someone different is making the payments, how quickly can you refi or flip it etc etc. I will say briefly that you can mitigate a lot of these risks by using creative structures, but Ill save the details for another time.
So in summary, the title company's job is not to pay off all liens. It is to do what ever you tell it to in the sales contract or escrow instructions. If you accept certain exceptions they will happily give you a limited warranty deed. Its the banks job to enforce the terms of their arrangement, not anyone else's.
- Real Estate Investor · Livonia, MI · Member since 2008 · 50 posts · 8 votes11y
@Chris Ambrosio it would be great to get more details on "creative structures" when you can find the time. Thx.
- Musician & Real Estate Investor · Edmonds, WA · Member since 2014 · 43 posts · 12 votes11y
Hey @Chris A.
Thanks for the breakdown, much appreciated! So, to summarize, do I understand correctly:
- The County "records" property ownership by documenting when Deed are filed, but the County does not perform any checks to see if the transfer of ownership is "ok" based on existing Liens and their stipulations, etc.
- Two parties can agree to sell a property and simply notify the County that the sale has occurred. At that point, if any existing Liens wish to perform action in response to the change in ownership (such as exercise a Due on Sale clause) it would be up to them to do so.
Question: In a "subject to" sale, does the transfer of the property generate any event that would cause the Mortgage/Bank to become aware that the property has changed hands? Or they would be blissfully unaware as long as they get their monthly payments accordingly to schedule?
- Real Estate Investor · Tucson, AZ · Member since 2015 · 17 posts · 18 votes11y
@Jeremy Jones, Seems like you got it man!
The county does not check what they documents are or who executed them. There have been cases of hate groups or angry persons forging peoples signatures to record documents to encumber property. Obviously the stuff doesn't stand up, but you still have to go to court and have them issue a judgment to clear your title to the property which can be expensive.
When two parties exchange a property and record a deed with the county, the county is 'posting' it to the public record. You are not notifying the county so much as giving everyone in the wide world who might care to look, notice of what you did. All you have to do to transfer something is make it generally known. Property laws require you do that by giving public notice at the recorder.
There are three ways that I know of why a lender would get notice of a transfer: 1) They review the property records regularly and see that a deed was posted (I think we already understand that this is unlikely since it would be an expensive, time consuming hassle). 2) There notice a different name on the payment check. 3) Insurance beneficiaries change. Lenders required they be name additional insured on an owners insurance policy, If you get insurance put in your name as the buyer, the corresponding change will also be sent to the lender.
Jeremy, Courts want to encourage efficiency in the market by allowing freedom of contract and efficient breach. The Supreme court was clear that its not fraud to violate a due on sale and other lesser courts have said you cant be sued for intentionally trying to conceal a sale because you have no duty to notify them.
To get at @Jon Quigley's question, I usually break down the risk a few ways:
1. Is there a due on sale clause? Read the loan documents and see if it even exists. If it doesn't, no problem carry on.
2. There is a due on sale clause, but I don't care. Why wouldn't I care?
a. The loan was with a huge bank, or service by MERS and sold to a collateralized pool. No one knows where the note is, or who holds it, so none of the 3 ways a lender could recognize the transfer are triggered. The people who would understand who really needs to be paying are so far removed from the people processing the payment, that as long as payment keeps coming in no alarms are raised and no one is the wiser.
b. It doesn't matter to me if they find out because by the time they figure out what happened, send notice of their intent to foreclose, and waited the legally required time before they can foreclose, I've renovated the property or turned around the cash flows and have new financing ready to go, or a buyer lined up. Worst case scenario I can throw the property into bankruptcy the day before the foreclosure, drag my feet filing schedules, and buy myself another month or two to get the property stabilized.
3. There is a due on sale clause, and Im worried that the bank is going to call the loan.
Seller sets up a trust where he is the trustee and beneficiary under the trust. He transfers the property to the trust. This isnt a volition of due on sale because its technically still him as the owner, just though his trust. Now you and the seller do your deal, he quietly transfers beneficial interest in the trust to you as the new owner (this is not a recorded event and the only record of it is the docs between you). Seller stays on as the trustee so that payment and insurance still have his name on them. He gives you all the checkbooks and stuff so there is really no work for him, and any extra work he feels like he would have to do means an increase in purchase price for him. Loan gets paid as normal and no one is the wiser.
The second option is to do some sort of wrap loan where you pay to account servicing, they take whatever portion of the money they need to and then pay it on behalf of the seller to the old first loan. This makes it look like the payment is coming from the same place, but does not overcome the record change and insurance issues.
Im painting with really broad strokes here, but you get the idea. Obviously, if you are going to pull a move with this level of sophistication you need to get a good real estate and tax attorney to make sure everything is kosher for your particular state laws.
In my experience lenders hardly ever notice and wont push the issue until interest rates start going up...people will sell subject to so that the buyer can stay with a low fixed rate when the rate environment is higher. Banks obviously need to move their loans with the interest rates so now they have an incentive to push for DOS.
Hope that helps.
- Residential Real Estate Broker · Memphis, TN · Member since 2015 · 84 posts · 60 votes11y
@Chris A., thanks for the thorough breakdown.
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
subject too means exactly that your taking title SUBJECT TOO the existing encumberances. nothing more or nothing less. if you get a new loan then they will pay off the existing.
This is were sub too is dangerous when you make statements like you just did.
As in you don't care if the lender finds out and you would have it sold before the foreclosure actually happened all well and good for you as you have no risk as you pointed out...
The unethical and moral obligations to the seller are violated here by this kind of attitude.
When you fail to pay on a subordinate lien and or ( and I agree with you that its rare to the extreme) that a mortgage gets called for alienations of title.. but if it does and you don't care because you will be out of it before you lose the property.. What happens to the Seller who did the deal... YOu have just TRASHED their credit.. A notice of default is one of the worse things that can happen to someone's credit and buy the time they figure it out its usually to late or they have thought the property was sold to this nice sub too investor and have forgotten about it... Then you have what is a very dangerous thing as well were you have all these newbies and wanna bees with no real capital get into the deals then can't pay the underlying because they are thinking hey I will just flip it does not hurt their credit and they only stand to gain.. especially when people get into these deals with a few hundred bucks.. then you really have the scoundrals who never make a payment and rip the rents for as long as the foreclosure process takes.. and in some states that is a long time.
So Sub too being a viable strategy in the hands of the wrong person or someone with your attitude ( hey by the time they figure it out and foreclose I will be down the road) is a dangerous deal for the poor seller who gets totally abused credit wise and emotionally .
So its seller beware.. and It would be great if you would think about the seller not the person trying to do this and get a sense that they are off scott free and who cares if a loan gets called.
- Real Estate Investor · Tucson, AZ · Member since 2015 · 17 posts · 18 votes11y
Jay, Im sorry that my post upset you. You are right, that it is powerful information and in the wrong hands could do a lot of damage to the average consumer. Most of my transactions are business to business, and I guess I assume a higher level of sophistication when I write my responses (I know Jeremy is reasonably experienced), and sometimes assume, incorrectly, that the seller knows they need to take the potential risks into account when determining their sales price.
I could have worded the post better. My intention was not to express my personal views or attitude, but to illustrate two different extremes: one when the investor is worried about due on sale and one when they aren't. I guess I made the point to strongly, but there are times when both the buyer and seller really aren't worried about the loan, such as in a business to business transaction or when the seller is already in a bankruptcy or foreclosure or the property is in distressed condition. In those cases the hammer is already falling and the seller would be happy to get anything they can from a buyer who is willing to take the property subject to. They understand the risks upfront.
So in summary: My statements were a poor shot at showing the two opposite extreme possibilities in a situation, and weren't meant to suggest that people approach sellers with the intention of not making good on their obligation. I do my best to do right by people and realize how that statement could have been interpreted differently.
- Real Estate Investor · Tucson, AZ · Member since 2015 · 17 posts · 18 votes11y
@Jay Hinrichs, also just wanted to note that you picked out the one scenario I mentioned that could hurt a seller, but I also gave examples of three or four others that wouldn't. Your statements kind of seem like an unfair characterization of my post and I would appreciate an apology.
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
NP I assumed so.. But BP you have to remember there are 200k viewers here that are just beginning...and some of this stuff is like giving a 6 year old a loaded gun.. then there are others that are just plain crooks and we don't need to feed those trolls
And of course if the sellers credit is already trashed then it does not matter.
there was a group of investors here in Oregon that followed one of the Guru advices on doing sub too's and they were good at it amassing 35 of them.. Well they then did the Joe Picket routine and sold on contract with low down to folks.. Well we know how well that works. So they wrapped all these sub too's with owner occ ( pre dodd frank) sales and recorded them all... with the guru teaching them that they will make the delta of 200 to 400 a month on each one... sounds good in theory.. And they were not buying distressed assets just FSBO's well one by one of course the low down owner occ's started defaulting. And soon they did not have enough cash flow to cover the mortgage they wrapped. By the time they came to me it was a mess.. I worked them out of most of them I cashed out the better ones taking them over.. But they got turned into the AG and got in a pot full of trouble. and of course many of these sellers got their credit trashed..
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
I reread your post and disagree with your characterization.. you make statements like throwing it into bankruptcy and dragging your feet.. I did not see where you stated that if you pull a unsuspecting seller into this deal and you default that your going to crush their credit. so I stand by my statement... I am sure your a smart dude probably much smarter than myself .. but I just wanted to point out that there is some moral obligation to sellers you will have people doing these all over the country with unsophisticated sellers who have no clue...
Not being as bright as many I make up with it by volume having done hundreds of these prior to the equity stripping laws and pre foreclosure laws changing in 08.. and I was doing wraps in mid 80S before most folks were even thinking about RE... had a company called California Wrap in the day.. probably did 500 or more of those.. in that scenario we only wrapped seller carry so there was never a risk of credit destruction for a seller.
- Real Estate Investor · Livonia, MI · Member since 2008 · 50 posts · 8 votes11y
Thanks @Jay Hinrichs and @Chris Ambrosio I also found the following online-seems a good summary of risks and legality: http://www.johntreed.com/dueonsale.html
But I have a simple question - how does one get the payment coupons to come to a new address and isn't this something that would naturally reflect a new payer on the note? And what is the mechanism - do we just send them a letter saying to send the coupons to a new address? Seems trivial but I'm not clear on how to do this step on Sub2.
thx
Jon
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes11y
Well, Chris, I too have many issues with all that, some accurate statements but some are not so much. At 12 posts, understand that we speak to more of a national audience than by experiences one may have gained in one state or one area.
Podcast #70 is the worst one on BP, search the forums and you'll find the concerns that have already been addressed. I guess it remains up to generate posts that drive the ads that keep checks going to the bank. I suggest people not go there, but knowing that if I say that, more will go see, so if you're that type, look up the forum threads that address the issues.
A Sub-To is not done with a General Warranty Deed, it is accomplished with a Special Warranty Deed or similar deed that grants title excepting out any warranty as to liens or encumbrances. You take title "subject to" existing liens.
Title is granted except that interest that was granted to a lender as an assignment as security or in a title state, that title interest granted to a lender. The title insurance only covers that interest conveyed by the grantor, the seller, nothing more.
I also see competition for Dion for the longest winded post awards. :)
- Real Estate Investor · Tucson, AZ · Member since 2015 · 17 posts · 18 votes11y
@Jay Hinrichs, You're right, and I will definitely tone down my posts in the future. You have great experience we can learn from, and I can see where you are coming from. I've never done a deal with a seller who would be at risk, and gambling with someone else's livelihood is just not something I am comfortable with.
The only think I can do to justify my bankruptcy statement is to give you a real example: An old woman passed away. She had a reverses mortgage and other liens that far exceeded the value of the property (it was in disrepair). We bought the property from the heirs subject to the mortgages. They just wanted out because there was no equity and the lender was starting a foreclosure. So we started our renovation under the gun of a pending foreclosure (the house had some structural problems, she was a hoarder, and the prop been updated since the 70s). We got part way though, but there was some permitting problems that took longer thank we thought, and right before the foreclosure had to throw the property in bankruptcy. We drug our feet to buy us time to get the permits sorted, and when we finally showed our plan to the court, they approved it because it was a win, win, win: The heirs got something when they weren't going to get anything, the bank got way more than they would have got in a foreclosure because we improved the property, and we made a nice pay day. No ones credit was hurt and we didn't have to feel like we were screwing anyone over....So I guess its just a matter of perspective.
But again, you are right about needing to show the dangers, and I will be more careful about what I post in the future.
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
spirited conversation is what BP is about.. and divergent view points. so all good on my end.
When I was personally involved with many sub toos prior to the new laws.. We were always in a position to cash them out.. so in the scenario you described we would have simply paid the loan off and went on our way...
But I fully understand the transaction as you present it.
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
you don't need a coupon to make a payment.. just send your check in with the account number written in the memo section and or a little sticky note.
- Investor · Sherman Oaks, CA · Member since 2008 · 6k+ posts · 3k+ votes11y
Warning new people about sub2, great job.
AG and FBI look at someone giving up the deed and "promising to make the payments" as serious potential fraud business.
Sub 2 strategy is a terrific strategy but you need to be strict about the payment and be able to either refinance or payoff the existing financing.
Many new folks think sub 2 and wraps are "saviors" to their financial situation. You need some financial means to do a lot of them. Private IRA lenders and Joint Venture partners are helpful with wraps and sub2 in case the loan gets called.
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
the case here in Oregon were I jumped in and saved these kids that did the 30 plus deals. I have no doubt had I not helped them they would have been in serious trouble.
AS it was they spent quite a lot of money on attorneys negotiating with the AG.. and that was 05 ish... today you are correct and the FBI would be pretty interested in the equity skimming aspect. Its the reason I stopped doing this in 08 all together not worth the risk reward... you get a wonky seller that starts screaming at the top of their lungs and you have just created a nice Cluster @#% for yourself.
- Investor · Sherman Oaks, CA · Member since 2008 · 6k+ posts · 3k+ votes11y
- Musician & Real Estate Investor · Edmonds, WA · Member since 2014 · 43 posts · 12 votes11y
@Chris A. thanks for your explanations, I'm starting to get a better picture of things. So in a Subject-To purchase, would I approach a Title company with a Purchase & Sale Agreement? Or would it be better to find a good real estate lawyer to execute this type of transaction?
The scenario I'm interested is different from the distressed seller alluded to in some of the above posts. I'm thinking of a scenario where the owner/landlord of a multifamily property is getting burned out managing tenants/repairs, is stuck with low rents, and wants to get rid of the property and move on to other things. As a specific example, I'm looking at a 5-plex that has an ARV of $500k. The owner wants $350k and told me he owes $116k on his first mortgage and would be willing to Seller Finance the rest.
Could I do a Subject-To offer which would allow me to take over his 1st Mortgage of $116k plus add a Deed of Trust for $220k of Seller Financing? That way I could perform renovations while making payments on the 1st Mortgage and the Seller Financing, and then upon completing the fix-up and getting the leases up to market rates, I could refi into a commercial loan.
Thanks for any thoughts you may have on this possibility!
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes11y
Half million on a property? Get a lawyer! If you don't now, chances are good you will need to later on, it's much cheaper now! :)
- Real Estate Investor · Livonia, MI · Member since 2008 · 50 posts · 8 votes11y
@Chris Ambrosio and all, can any of you provide the details of or a link to a contract that would be used for Sub2? How similar/different is it to a regular purchase agreement? What clauses are included or excluded? A completed example (with no names/addresses) would be great to see. Thx.
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
what you describe is a very simple transaction and completely do able you don't need a lawyer you just need a purchase and sale agreement.. when you have a seller like this that owns commercial property and is not a poor defenseless home owner its completely different. the seller will know his or her risks.. If the first was to get called he would have to pay it off to protect his second. the seller can continue to make his payments as he does not want to risk hurting his credit.. if you default he takes it back etc.
This is a very simple transaction and a good one for you to leverage into .. You could pay a COMMERICAL RE broker a small fee to do the contract for you.. Or of course you could have an attorney write a contract for you as well.. or even a plain jane or joe RE broker..
Again in my mind very simple vanilla deal that should be a good on for you as long as you are confident in your values at the end of the day...
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes11y
You can use a standard contract, it should have a financing section, there, simply state that the subject property sold is taken subject to the existing mortgage, estimate the payoff, use other financing to fill in the money gap with your down payment. State that the amount taken subject to is subject to the payoff to the date of settlement.
Then, there will be a title requirements or settlement procedures recited in the standard contract, it will probably refer to a General Warranty Deed, this needs to be changed to a Special Warranty Deed or All Inclusive Deed depending on what is used in your state. Might be easier to add an addendum and state that any reference to a GWD shall mean a SWD. That the purchase is subject to the existing mortgage and specify that mortgage by the date made, lender and original amount of the loan. If you have book and page or recording information of that mortgage, state that.
Then give the settlement agent/closer, a closing letter of instructions, state that the payoff as of settlement determines the amount to subtract from the purchase price and to subtract arranged financing to give notice of amounts required to close. They will take care of the details. :)
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
one would usually use an AIDT if the seller were trying to make interest on the entire amount of the purchase price.. IE your buying it for 350k and he is going to charge you interest at 9% on the entire 350k... And his interest on the first is only 5% he makes the delta on the difference and the total number.
If you take sub too and the first is 5% then that is your payment and the seller just takes a second like you describe at 9% you only pay interest at 9% on the 220k not the entire 350k.. so it saves you some interest expense if you can do a sub too and a second as opposed to an AIDT.. We did hundreds of AIDT's in the day in CA its a great tool for us as the seller because we were wrapping low interest seller carry firsts that we acquired in the early 80S then interest shot up to 15 to 18% so we used the AITD and wrote the interest at the rate of the day and made the delta between them.. that was some good paper for sure.
wrapping 6% notes with 18% AIDT's
AIDT = all inclusive deed of trust a common California instrument.
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
google All inclusive Deed of Trust state of CA and see if the document pops up... its self explanatory
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