Pace Morby is the cohost of A&E TV series, Triple Digit Flip, and runs one of the largest real estate investing communities, SubTo.
If you were one of the fortunate people to invest in a residential property during the 2020-2022 real estate peak, you might have locked your mortgage in at a record-low interest rate. But what happens if unexpected financial difficulties arise and you can no longer keep up with your payments, even at those lower rates?
Enter buying properties through “subject-to” contracts, a real estate investing strategy that uses creative financing to help struggling investors maintain their credit and avoid foreclosure.
Subject-to contracts have emerged as an option for investors facing foreclosure and/or struggling to secure traditional financing. As a real estate investor myself, I have used this approach for years and have allowed homeowners to sell their homes while preserving their credit, as well as helped buyers achieve their dreams of homeownership.
What is a subject-to contract?
Using subject-to contracts, a buyer takes over a seller’s existing mortgage payments without needing a new mortgage, having to run a credit check, needing previous home-buying experience or putting your own cash down. This strategy can be particularly helpful for investors needing to sell off their properties quickly or who are at risk of foreclosure, as it enables these people to escape their mortgage obligations without harming their credit.
This method can also benefit buyers who might not qualify for conventional financing, such as those with imperfect credit or self-employed individuals who would traditionally have a much harder time qualifying for a traditional mortgage. It might even be a good way to acquire properties for any investors who don’t want to have to undergo the extensive process of verifying income and debt to banks to get approved for a mortgage.
In other words, these contracts can allow investors to potentially avoid foreclosure and alleviate the burden of a property that no longer works for them. Buyers then can attain ownership, and neighborhoods and communities can be revitalized.
Where can you use a subject-to contract?
Taking over properties using subject-to contracts is a viable option for investors all over the country, and has been quite successful for me personally in my own backyard of Phoenix, Arizona. Why? Well, the simple answer is that home prices in the valley have seen some hefty appreciation in the last few years.
In Phoenix alone, the median home price is still around $410,000, which is over $100,000 more expensive than just three years ago. With the median household income only around $65,000, how is the average person meant to afford a home in today’s market?
One option is with subject-to contracts.
It’s important to note that this type of real estate transaction occupies a “gray area” in terms of legality versus industry best practices. To be clear, subject-to real estate contracts are NOT illegal, but they are often conducted “under the table” (e.g., outside the prying eyes of traditional lenders).
It’s precisely because of this exclusion of the banking middleman that many in the lending industry have strong feelings about subject-to contracts. This is somewhat ironic, as a homeowner typically chooses to go the subject-to route only AFTER being rejected for refinancing options and/or an impending foreclosure from the bank.
In general, formal regulation of these transactions can be somewhat thin, and finding answers regarding your subject-to contract questions can sometimes prove difficult. For this reason, it is advisable to check with your local and state NAR (National Association of Realtors) chapter to gain insight on any particular restrictions regarding this type of transaction in your area.
What challenges should investors consider?
The due-on-sale clause is one of the most critical considerations in subject-to real estate transactions, particularly for investors aiming to transfer property ownership without triggering loan acceleration by the lender. After all, the benefits of putting little to no money down on a subject-to transaction are all but nullified if the bank discovers the deal and demands full payment of the existing mortgage as a penalty.
This is arguably the biggest risk that homeowners and investors face in subject-to contracts.
However, there is a strategic tool available that can help investors circumvent the risks associated with this clause and safeguard their assets from civil liability: land trusts.
To mitigate the risks associated with the due-on-sale clause, investors can turn to land trusts (sometimes referred to as “grantor trusts”) as a strategic tool. We’ll cover this more in a future article, but for now here’s what you should know:
An asset protection trust, such as a land trust, serves as an effective mechanism to transfer property ownership without triggering loan acceleration.
The best way to understand a land trust is to think of it as a box that will hold your asset for you under the protection/guidance of a trustee. From there you can assign a beneficiary (the investor) to receive the asset if certain conditions are met. This is an oversimplified version of the legal mechanism, but it serves as a good springboard for understanding.
From a practical standpoint, a land trust acts as a protective legal shield designed to hold real estate assets and remove them from the danger of bank penalties such as loan acceleration.
As an advocate for education, I firmly believe that anyone can succeed in real estate investing in almost any market in the country with the proper knowledge and support. It’s important that real estate agents, brokers and potential investors alike learn how to leverage subject-to as a powerful tool not only for growing and maintaining their private portfolios, but also for building wealth through real estate without relying on one’s own cash, credit or previous experience in real estate.
The information provided here is not intended as financial advice. You should consult with a licensed professional for advice concerning your specific investment, tax, or financial situation.
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