How do you build equity with Subject-to financing?

Question

This may come down to not understanding Subject to as well as I need to, but I had a few questions on the strategy as it relates to payments and equity built in the property. For context, I am trying to figure out if I can use this strategy for a primary and ideally a primary that I house hack with a short/mid term rental in the basement.

1. When buying a property subject to, I understand that you are taking over the seller's mortgage payments. If you are paying off someone else's debt, how do you build your own equity in the property if the debt and ownership have been separated essentially?

2. For example purposes, let's say someone bought a house for 100k, they owe another 50k, and you buy it from them for 150k. Would you essentially take over the 50k left in mortgage payments and then create separate terms for the 50k on top? Therefore having essentially 2 different payments to service?

Thank you for any help! Just trying to wrap my head around the concept better.

Brad Jacobson · Answer

Hi Michael,

Yes, you've got the basic concept of buying a property subject to.

In that same example (seller's owe $50,000, you purchase for $150,000), the terms you create for the financing should have a balloon payment along with enough monthly to cover their mortgage and provide them some cashflow.  It's normal to have terms of 3-5 years but they can be anything the parties agree to.

The hope is that in 3-5 years, you've forced appreciation on the property (rehab, value add, whatever) and the market has continued to push values upwards.  Then, say, the property could be worth $200,000.  At that point, you'd be able to secure long term financing through a traditional mortgage.

When securing long term financing, you'll be able to cash out 80% of ARV (in the $200,000 case, this would be $160,000).  You'd get to keep the $10,000, pay off the seller's $150,000 (or whatever amount is owed at that point if some of the payments were paying down principal), and then be left with 20% equity in the property.

Hopefully that makes sense.  Good luck!

Michael Kussin · Answer

Thank you so much - this totally helps! Funny how you just need someone to break down additional steps in a simple way and it makes more sense.

This may be looking into it further than necessary, but this now brings up more questions. Let's say the seller is an angel and agrees to a 30 year term because they want to avoid a lump sum of cash getting hit with taxes. Does this cause issues during refi? Or is that simply not my problem to worry about?

Additionally, in either situation (the one you laid out or my angel seller), are you able to take out a HELOC on any note carried by an individual? Or can you only borrow against equity with a bank?

I appreciate all the help here!

Eliott Elias · Answer

You ideally want to buy it with equity. Only way you build equity is with time, even that is not guaranteed. The real draw to subto and assumptions is taking over a low interest rate and having low monthly payments with little cash out of pockets.

If you are paying more than what the owner owes you either give the difference in cash or wrap the loan with the remainder

Curt Smith · Answer

I hold several rentals I bought sub to and just closed on one last week.  Sub to docs are the most complicated of all deal types and hate to think a new investor might screw the docs up trying to close sub to, I have a free training doc I give away that gives all doc examples and how to close.  Connect then PM me I'll send you the training.

You own the deed, thus you have rights to the appreciation and ALL tax advantages of depreciation, deducting interest paid etc.  No dif from buying with new mortgage in y9ur name.  Just someone else qualified and got the debt, which today is low interest vs the high interest new debt!!

Even if the at the time of closing you are even with AS-IS value, as my recent closing was, I will get all of the future appreciation (paper gain) as the neighborhood and future sales (comps) go up.  Its a nice house I just bought from a devorcee wanting to bail and move on.  I have it on zillow rentals.  Look up 7 edwards terr chattanooga tn for pictures.

Debt balance $262k,  He wanted $50k to walk, my wife and i met walked the house (a practiced good cop-bad cop tag team) she blurts out this really isn't worth $50k?!?! I then figured numbers on a pad and showed that $40k at closing was generous.  He agreed.  So I'm all in for $302k plus closing costs $2k, plus fix up costs $5k for approx $310k the as-is value today (at high interest rates).  I'm certain the area will appreciate a bunch going forward.

Now, the appreciation is all paper.  Available only when you sell.  I would NEVER (EVER) replace someone elses debt with my own even to cash out refi.  I would knaw off my arm before I would REFI out someone elses debt.  When you have a lot of doors and debt you'll realize the value of debt NOT in your name.

Focus on cash flow day one on any deal.  No exceptions for sub to.   This deal the PITI today is $1600, rent $2300 (low) and the FHA PMI insurance payment part is $400.   I just need to wait and pay for an appraisal so the LTV is better then 80% and poof I can get the PMI removed and have more cash flow.  Yes yes there/s problems for the seller wnen you buy sub tos that are FHA or VA.  Won't get into that here.

Best to all, curt

Curt Smith · Answer

@kerry, all benefits follow who owns the the property, the warrantee deed.  Just get the 1098 from the bank, see my training doc on use of the POA, power of attorney (etc) to work with the bank changing the mailing address, you are now the trustee of 123 Main St Family trust (see my training) and thus have full control over the mortgage in the bank's eyes.  Never a problem.  A few times some more hoops to jump per each bank, but with POA and deed in a trust you can work through the issies.

But taxes, depreciation, interest paid; you as owner just claim on your Schedule E for this house what you paid.  Depreciation is calculated based on your cost basis;  See the closing statement for the "price paid" which is the balance of the mortgage plus what you gave the seller, closing costs, AND fixup costs = cost basis.  Schedule E depreciates your cost basis over 27.5 yrs.   No changes in how you file taxes for buying sub to vs cash vs new mortgage.

best to all, curt

Kerry Conrad · Answer

Curt,

Can you explain how to claim mortgage interest when doing a sub to?  The loan stays in the sellers name, doesn't he get to claim mortgage interest, as well as other benefits?

Brad Jacobson · Answer

If the note is for 30yrs, you'll want to confirm if there's a penalty for an early pay-off.  Most (maybe all) traditional 30yr mortgages today have no pre-penalty but an angel carried 30yr could be different.  Make sure to confirm!

In Utah, the owner has title to a property even if the property is still leveraged by another investor or bank.  Therefore, in Utah you can still do HELOCs and other financing tools but I believe this can vary from state to state, perhaps even from credit union to credit union.  It'd be best to confirm if your angel investor's contract speaks to this option or not.

How do you build equity with Subject-to financing?

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