“Subject to” options

[Teddy Grooms]

Who has experience with the “subject to” option?

I’m curious as to what types of loans and/or what banks/institutions DO NOT allow “subject to” take over options? Thanks guys!

[Don Konipol]

@Teddy Grooms

Almost all mortgage loans are written with a clause that allows the lender to accelerate the note if the property ownership is transferred. This is known as the “due on sale” clause.

Before 1976, mortgage loans rarely had a due on sale clause. Even after 1976, until 1980, VA, and FHA loan did not contain that clause. So, buyers were able either to assume the mortgage note (liability), purchase the property leaving the note in place but without assuming liability ( purchasing a property "subject to" the mortgage note).

Even today, there is nothing illegal about purchasing a property subject to the existing mortgage....however, the lender has the option of accelerating the note as the transfer of ownership violates the due on sale covenant.

So, purchasing a property subject to a mortgage note is usually done with steps taken to lessen the likelihood that the lender will find out about the property transfer. If the lender does find out and chooses to accelerate the note, the property owner will have to pay off the note to protect his equity interest and to protect the sellers credit and liability from a default judgement. It would get very “messy”.

Few notes are called for violation of due on sale when the payments continue to be made in the name of the borrower of record, quite easy to due with electronic funds transfer. Of course, since title is a public record, should the lender ever become motivated to aggressively enforce the due on sale clause, running title reports on portfolio loans is quite easy. The two main scenarios where the lender would have an incentive to do such would be if and when interest rates rise dramatically or when a lender has purchased the note from the existing note holder at a discount.

Back before the due on sale clause became standard, properties where purchased subject to the mortgage, or with a mortgage assumption to (1) preserve a lower than market interest rates when rates rose from 4% to 18% in a matter of 5 years, (2) to purchase a property where the borrower would not qualify for a new loan, (3) to finalize a property transfer faster than if a new loan was obtained and (4) to save the fees involved for loan origination, processing, underwriting, etc.

Today, subject to property acquisition works best from a buyer perspective when he is able to buy the property with little or know down payment, so his equity exposure is minimal and he has no liability for note payment. If the buyer can rent the property for more than his expenses, including note payments, he may be able to obtain a high % return on his invested cash, as his invested cash would be low. Further, he would essentially obtain a call option on the property for the amount of the down payment....., if the property value increases significantly in the future he can sell having utilized significant leverage without having incurred liability, while if property values decrease he can essentially default having lost only his low down payment. While most buyers utilizing subject to financing will claim that under no circumstances would they willingly default on the loan, the property value decrease of 60% in 2008 thru 2011 in Nevada, Florida and Arizona showed this statement to be completely false. Faced with a property value of say $60,000 and a note of $150,000, subject to owners defaulted in droves, with no liability or knock on their credit. Unfortunately, this was not the case for the people who had sold them the property and retained liability for the note.