A Subject to Mortgage: What Is It and How Does It Work?

You can take different paths to finance a house, even if you’re a first-time buyer. One such option is going the subject-to-mortgage route. You need to know what this means as a homebuyer and how it works.

What is a subject-to-mortgage?

The term “subject-to-mortgage” refers to real estate transactions in which a property with a pending mortgage loan is sold to a homebuyer. Meanwhile, the seller is still obligated to pay off the mortgage loan.

“This is unusual because the homeowner should be responsible for the mortgage,” said Lynne Martin, an investment advisor and owner of Cash for Houses in Denver. “However, in a subject-to-mortgage, the title deeds are transferred to the buyer, but the seller is still responsible for settling the mortgage.”

This transfer of ownership is done without the lender’s permission. While it has its benefits, it also has unique risks, like triggering an acceleration clause.

“Homesellers usually do a subject-to mortgage if they cannot afford the mortgage, and after the transfer of deeds, the buyer is now obligated to make monthly payments the buyer uses to pay the mortgage and earn income,” Martin said. “Remember that the buyer only has to make monthly payments. The mortgage loan is still in the seller’s name.”

Subject to mortgage types

As with many aspects of real estate, there are various types of subject-to-mortgage transactions.

Subject-to-cash loan

In a subject-to-cash-to-loan, the buyer pays the sales price set for the home and the difference between the sales price and the loan balance.

“For example, if you assume that the seller has an outstanding loan of $100,000 and is selling the property for $200,000, in a subject-to-cash-to deal, the buyer pays the purchase price of the home which is $200,000, and the difference between loan balance and purchase price which is $100,000, Martin explained. “This is the most common type in use and the other types incorporate it.”

Subject-to with cash carry-back loan

Also called owner financing, this type of subject-to is similar to obtaining a second mortgage, Martin said. For example, if a buyer has to pay $100,000, they can make a down payment of $60,000 and then renegotiate the remaining balance of $40,000 with the seller. The negotiations could have them paying half of the balance to the seller with new terms and interest rate, and another to the lender, she said.

“Subject-to with cash carry-back gives sellers the option to set terms that would give them a carryback on the payment of the loan,” Martin said. “The buyer pays a part of it to the mortgage lender and another to the seller at a different interest rate. In the simplest terms, it is a second mortgage settled by the buyer.”

Wrap-around subject-to mortgage

Another type of subject-to-mortgage is a wrap-around subject-to-mortgage, in which the seller can profit from the loan balance by putting additional interest on the loan’s interest rate.

“[For example, if] the existing mortgage has a 3% interest rate and sales price is $200,000, the buyer can make a down payment of $30,000 while the seller carries back $170,000,” Martin said. “However, the seller charges the buyer an interest rate of 4% and earns a profit on both existing mortgage and the balance of $40,000.”

Subject to vs. assume mortgage

The key to understanding the difference between subject-to and subject-assume is knowing whether the loan obligations were transferred or not. In subject-to, the homebuyer receives only the property, whereas in subject assume, the property’s title deeds and the mortgage loan obligations are transferred to the buyer.

“This means that the homebuyer in a subject-assume mortgage deal is responsible for the loan and directly faces any penalties for defaulting,” Martin said. “On the other hand, the seller retains the loan in a subject-to transaction. Choosing depends on the loan the seller secured and any benefits you get.”

With an assumable mortgage, the buyer also does not have to undergo the tedious loan process that includes background checks and credit scores. “You can also get an advantage in low-interest rates,” Martin said. “However, if the market becomes unfavorable and the home value drops, you will still have to pay the loan.”

Finally, for subject-to-mortgage, the buyer’s advantages are no down payment and no mortgage application. The disadvantage, on the other hand, is property foreclosure if the seller does not pay the mortgage.

Reasons to buy a subject-to property

According to Martin, it’s not surprising that buying a subject-to property is appealing to homebuyers because it can appear straightforward compared to traditional real estate if you ignore the inherent risks.

“It is the lure of investing in real estate without the drawback of mortgages that interests most homebuyers who buy these properties,” Martin said. “Homebuyers do not need to apply for a mortgage, fish their pockets for a down-payment deposit or worry about their credit score. Once the transaction is completed, the new owner can quickly fix and resell the property. They are not restrained by mortgage obligations and will have made a profit.”

Pros of buying subject to mortgage property

• The guarantee of quick cash flow. “This is because the buyer immediately assumes full ownership of property once bought,” Martin said. “The seller is left with the mortgage.”

• Credit score is a non-issue. “Buyers do not have to worry about their credit history because sellers do not base transactions on it,” Martin said.

Cons of buying subject to mortgage property

• Their finality. This is their biggest con, according to Martin. “Once a deal is made, there is no turning back,” she said. “Almost inevitably, you would want to make some changes but this cannot be granted, and you will have to pay the mortgage loan as agreed.”
• The date for the loan payment can be moved forward. “This is done by some lenders who fear irregularities in loan payment,” Martin explained. “Accelerating the loan payment puts urgency and significant stress on the buyer.”

How to find subject to mortgage properties

When it comes to finding subject-to-mortgage properties, one of the most effective methods is to look for distressed properties where a seller may be struggling to make mortgage payments and can’t afford to make repairs (these may also be foreclosure homes). You can find distressed homes by searching the Multiple Listing Service, or MLS. You may also have success in finding a subject to mortgage property by asking homeowners directly about it.

Bottom line

Buying a subject-to property can be worthwhile for buyers and sellers if you analyze your situation and weigh the risks and advantages. Talking to a real estate professional can help you determine if it’s the right choice for you.