Buying Houses Subject To the Existing Mortgage

On today's podcast episode, I talk about buying houses subject to the existing mortgage. This investment strategy is also known as "assuming the mortgage" or buying "subject to".  As prices have pulled back around 15% from the peak, many sellers are realizing that they will not be able to get their Zillow estimate if they sell their house. There are a lot of people who purchased houses 3 years ago when interest rates were as low as 2.5% or 3% (on a 30 year fixed rate mortgage). Today the rate is 6.5% which is more than double what the rate was just 3 years ago. This has created an opportunity with many motivated seller leads where sellers are calling us and trying to sell their house. As an example, let's look at one of the leads that called my office recently. This was a young couple who had purchased their house for $225,000 a few years ago. They had put down $25,000 and their original loan balance was $200,000. Their interest rate was 3%. The interest component on their 30 year mortgage was a monthly payment of $843. With taxes and insurance the payment was $1,443. This seller was trying to sell their house and had it listed on the MLS for $250,000. This is what Zillow said the house was worth. However the house had been listed for over 90 days and other than a few low ball offers from wholesalers, there was only one real legitimate offer for $225,000. You may be wondering how I got in touch with this seller. I reached this seller by mailing a postcard campaign to a list that was NOT motivated and was just a broad mailing to all of the 3 bedroom, 2 bathroom home owners in this specific city. Not all sellers that are motivated to sell are on a motivated seller list. There are many sellers who may be paying their mortgage payments on time, who are not in foreclosure and who appear to have no distress at all. But some of these sellers really want to sell their house. Their motivation to sell as soon as possible makes them a motivated seller. In this scenario, this young couple had moved to Florida from the Northeast during the pandemic when they could work from home. Now a few years later, they want to sell their house and move back home to the North East which is where they are from. Zillow says their house is worth $250,000. That is the amount that they listed their house for, but all they have received is a bunch of low ball offers at around $200,000. They also received one potential offer of $225,000 but their realtor was concerned the buyer would not qualify for a mortgage. I asked them why they don't lower the asking price on the MLS and they said that they were sick and tired of showing the property every weekend and just wanted it sold. They were reviewing that one offer that came in for $225,000 but they realized that after paying the commission and closing costs, they would not be making any money from the sale and would be walking away and simply paying off the loan. They were looking at a scenario of maybe netting only $5,000. Even worse, they did not think the buyer would qualify and they could not afford to pay for any repairs that would be required after the inspection. They had discussed this scenario and were trying to figure out how to get a better offer or a little more.  That is where my postcard came in. And that is what prompted them to call me.  Their mortgage payment was $1,443. If I were to be taking over their mortgage payment that is what I would be paying per month to the bank.  Market rents in this area are around $2,000 per month. It's in a desirable area where there are many potential renters so it would be easy to find a tenant for $2,000. The house may even rent for $2,100 or $2,200 with some new paint and a cosmetic clean up.  So the first question I asked them is "why don't you rent the house out"? This is a key question to ask because it puts the seller on a footing where they start wondering why you are not interested in their house. Why would you advise them to keep it instead of buying it yourself? This is a great question to ask a seller.  Their answer was that they did not want to be landlords. I told them that there was no way I would be willing to pay $225,000 cash for this house. The only way I would possibly consider buying their house would be if I were taking over their mortgage payments. This is called buying a house "subject to the mortgage" or "assuming the mortgage". This is known in legal terms as a "quiet assumption" because you are not telling the bank that you are taking over the mortgage.  My offer was $5k cash and I would take over their mortgage payments. This scenario is very common because anyone who purchased 3 years ago when interest rates were really low, is looking at a price decline of 15% from what they paid for their house. So they are finding that their house is not as easy to sell for what they originally wanted to get for it. The reason for this is because while prices have pulled back, interest rates have more than doubled from 3% to 6.5%. The monthly mortgage payments don't make sense to buyers with interest rates at these levels. So there are less buyers, and sellers are having a harder time selling.  One interesting point is that 3 years ago people asked me "why would anyone sell when they have such a low payment"? Why wouldn't they just keep the house to keep that low interest rate locked in? The answer is because people sell when they need to sell. People sell because they want to move. People sell because they can't afford the mortgage payments because they lost their job. People sell for many different reasons. So this couple wanted to sell their house and  move back to the North East.  If I offer them $5,000 cash and I take over their $200,000 loan, my cost on the house is $205,000. If it is worth $250,000 that would be $45,000 of equity that I would be getting. If I rent out the house, I would make $600 a month in cash flow. That is $7,200 per year on a $5,000 investment. That's not a bad rate of return. If I paint the interior and brighten up the house, I may be able to even get a little more for rent and my cash flow could be $700 or $800 per month.  If they had multiple offers above asking price they would not be thinking about accepting my offer. But the problem for them, is that they have no offers other than the 225k offer and even that is not certain because the buyer may not qualify for a mortgage.  So they are seriously considering my offer. You can see that the market has changed. Buyers are now skittish and very reluctant to buy. In fact, there are now more sellers than buyers so the market has turned into a buyers market. Buyers are reluctant to buy for a number of reasons. The first reason is because they see that prices have come down, and conventional wisdom is that prices will continue to come down. I don't disagree with this logic (for now) as inventory is increasing it makes sense that prices would come down. If interest rates stay where they are, it is understandable that there will be fewer buyers. The second reason that buyers are hesitant to buy is because prices have increased by more than 50% in the last few years. Buyers have sticker shock at how high prices are relative to where they were just a few years ago. Finally, the number one reason why buyers are reluctant to buy is because when they go to their mortgage broker and price out a loan, they are effectively needing to pay 50% more to buy a house with a mortgage that is double the interest rate of what it was before. To put that into perspective a $200,000 mortgage at 6.5% is $1,264 per month in interest versus $843 per month in interest. That is 50% more per month in interest. Considering that property taxes and insurance have gone up dramatically too you can see how this creates an affordability issue. Even if the buyer is willing to pay, will the mortgage company approve the borrower? Will their debt to income ratio be in line? What if the buyer has just okay credit and their mortgage rate is 7.5%? Now their payment with taxes and insurance is over $2,000 and they are thinking they would rather just rent.     The net result is that the buyer looks at that mortgage payment with taxes and insurance and concludes that they are better off renting. Sellers are slowly starting to realize that their house may not be worth what Zillow says it is worth. Or to put it more accurately, buyers are no longer willing to pay that amount. That is why prices are declining. That is why you see so many price cuts on the MLS. There are now more sellers than buyers and it's becoming more and more difficult to sell. I anticipate that this will be the case for the rest of this year and going into next year too. As prices come down, I anticipate more foreclosures too. Many of these foreclosures will end up as bank owned properties.  So in this environment, where sellers may have a very low interest rate mortgage, and are wanting to sell but are not able to, you may be able to buy their house for substantially less than what they paid by simply buying the house and assuming their mortgage. Buying houses subject to is a very valuable strategy in today's market. If I can get the seller to agree to sell me their house with just $5,000 down then I could buy a $250,000 asset with just $5,000 down. This strategy allows me to buy multiple properties with very little money down. If the seller is really motivated, they may even accept an offer where I give them no money down at all and just take over the mortgage payments. In that scenario I would be buying with no money down. If you are looking to buy rental properties, and you are looking to buy with no money down (or very little money down) then buying houses subject to is a very powerful strategy for you to learn and add to your toolkit as an investor. Look for situations where you can pick up cash flow from the spread, where the monthly mortgage payment is quite a bit less than what the house could rent for. Also look for equity. Ideally pick up a minimum of 30k in equity on any deal that you buy subject to the existing mortgage. The more equity you can add the better.   Try and get at least $500 a month in cash flow. You need to be positive cash flow to cover maintenance and other expenses that come up from time to time. HOW TO STRUCTURE A SUBJECT TO DEAL how do you structure a subject to deal? One of the issues with "subject to" is that the original mortgage has what is called a "due on sale clause" The due on sale clause means that if a seller sells or transfer the property then the due on sale clause can be invoked and the mortgage can be made due and payable within 30 days.  I hear a lot of real estate gurus talk about how this never happens, but I think that is bad advice because it does happen. It can and does happen all the time. In fact, my very first deal was a package of 3 houses purchased from a motivated seller subject to the existing mortgage. On this deal, the seller picked up the phone and called the bank, and when the bank found out that the property was sold they called the loan due immediately. Was this the scary scenario that we expected it to be? No, we ultimately ended up getting a mortgage from the same bank at a very reasonable interest rate. The issue today, is that with interest rates at double what they were (or more), if your loan is called you would be refinancing at a much higher rate. Another issue is because banks know this, they are actively looking through their loans to see if there are any subject to deals which could be called (which would force the borrower to refinance at a higher rate or pay the loan in full). Don't be too afraid of buying subject to deals and the due on sale clause. You can always sell the property.   So how do you structure a due on sale clause to avoid the loan being called? Well there is a loop hole that was created by the Garn St Germaine Act in 1982 which was put into law by Ronald Reagan. This act specifically mentions the due on sale clause and talks about some exceptions to the due on sale clause. These exceptions are: 1. A husband transferring a property to a wife in the event of a divorce 2. A parent transferring a property to a child in the event of a death 3. A property that is put into a trust for estate planning purposes. Option 3 above is the loophole that you will need to use if you are buying a house subject to the existing mortgage.  Since a land trust is a type of Intervivos Trust like a living trust (which the act specifically mentions), it is perfectly permissible for an owner of a property to transfer their property into a land trust without invoking the due on sale clause.  Since land trusts are not recorded documents, no one can really see who the beneficiary of the land trust is. Even better, the beneficiary of a land trust can be changed at any time.  So in the event of a bank invoking the due on sale clause, producing a copy of the land trust should be sufficient for the bank to be placated. The way you structure this is a two step process. The first step is to have the seller transfer the property into a land trust. The second step is to have the seller change the beneficiary of the land trust. If the mortgage payments are paid on time, there should be no reason why the loan would be called. Remember this doesn't mean that it cannot be called just that it is not likely that it will be called.   The way many investors get tripped up on a due on sale is when the seller of the property cancels their insurance. This creates a letter being sent out to the lender notifying them that there is no insurance on the property. And then when the lender looks up the property, they see that the property has been transferred. So it is very important to make sure that the seller does not cancel the insurance.   I teach my students about how to structure a subject to deal in detail in my real estate training program. There are quite a few steps that need to be completed for this to be done correctly. We have a real estate training event next weekend where we will be covering this topic in detail. The above should not be construed as legal advice. Please consult with your attorney prior to implementing this strategy. If you do employ this strategy, have your attorney help you by preparing the land trust and handling the closing. This will make the seller more comfortable, and will also help you in the event that the loan is called since that attorney can help you navigate the process of negotiating with the bank.  It is very important that you disclose to the seller what you are doing. You don't want the seller saying they "did not know". This is why I recommend that you have an attorney draw up the trust and handle the closing and all of the paperwork. The attorney will make sure that the seller cannot claim they did not know what was happening. The attorney can explain to the seller how the process works. Find an attorney that specializes in subject to.   Buying a house subject to the existing mortgage is a very powerful strategy in today's market. There are many people who purchased properties when interest rates were very low that may now need to sell. And since prices are down 15% or more in some markets, those sellers are having a hard time selling their property.  These sellers may find you online if you have a motivated seller website. Or they may find you because of your marketing to them with direct mail. The traditional investor cash buying formula of ARV x 70% Less Repairs would not work with the seller in this scenario. If the house is worth $250,000 then 70% of that is $175,000. If the house needs $10,000 in repairs then your offer as a cash investor would be $165,000. But this won't work here because the seller owes the bank $200,000. Many wholesalers and new investors look at this as a dead lead and move on. But being able to ask the seller about their mortgage payment, and being able to immediately shift your strategy to potentially buying the house subject to their existing mortgage can turn a dead deal into a good deal.   If I take over their mortgage payments, then I can pick up $45,00 in equity, and add $600 a month in monthly cash flow. If I am only required to come out of pocket $5,000 to buy their house, then I can buy a lot more houses with this strategy. If you as an investor had $50,000 to spend you could buy 10 houses like this and control 2.5 million dollars of real estate with just $50,000. Do you see how powerful this strategy is? Owning more real estate with less money down allows you to substantially increase the size of your rental portfolio. More rental properties gives you more equity. More rental properties gives you more cash flow. If you buy with no money down, you can literally buy an unlimited amount of real estate. Make sure you don't have self limiting beliefs that are holding you back. Instead of saying to yourself "I will buy a rental when I have $50,000 saved up", or "I will buy a rental when interest rates go back down to 3%" ask yourself "How can I buy a rental with no money down"?  I teach my students how buy real estate with no money down at our real estate training events (boot camps). we have 6 live training events per year covering wholesaling, fixing and flipping, buying rentals, creative financing, buying foreclosures and bank owned properties and buying short term Airbnb's.   If you want to learn more about the Lex Levinrad Real Estate Training program call my office and speak to one of our Student Support Managers at (561) 948-2127.    To apply to join my real estate training program visit www.lexlevinrad.com/application