Taking Title ‘Subject To’ — A Caveat Or Two For Real Estate Investors — Don’t!

Posted @ 12:42 am - Filed under Real Estate Investing, Selling Income Property, Buying Income Property, Market Correction, Investment Lessons

There is information being propagated around the internet advising folks to take over properties ’subject to’ the existing financing. I’ve done dozens of those kinds of transactions back in the day, but no more. They’re not to be looked upon as an easy way to obtain financing. I lived through the ’subject to’ era of all time in San Diego, and I know whereof I speak.

First, some history.

Long, long ago in the age when NASA was the only user of computers outside of Cal Tech and the like, there was a clause known as ‘4c’ in the notes signed by property buyers for their lenders. Paragraph 4 sub-section c contained wording to the affect that you weren’t permitted to sell without paying off the loan in full. We called it the 4c clause. (Creative,weren’t we?)

The Depository Institutions Act of 1982, often referred to as the Garn-St. Germaine Act finally settled all arguments — due on sale clauses were enforceable by any lender as long as the clause was part of the original note. Game — Set — Match.

Bottom line? No more taking properties ’subject to’ without paying the piper. Borrowers can’t win this game if discovered. They have an ‘eight high nothing’ and the lenders have four aces and a wild card.

Here’s what’s been goin’ around.

You’re advised to find yourself a ‘good deal’ and simply take over the loan. Sounds pretty cool, right? Back in the day finding and carrying out ‘capital punishment’ lender style was the penalty lenders brought to bear for taking title ’subject to’.

Without being super technical, the lender has the legal right to decide who pays their loans’ payments and who doesn’t as mentioned above. If you buy a property and simply take over the seller’s existing loan, and the lender discovers this, they can call the loan at any time. Poof! If you can’t qualify to assume that loan, (that’s if they’re not too P.O.ed at you and will allow it) or can’t get a new one, they’ll foreclose. Your down payment and any other money you’ve invested into it is lost.

Oh, they forgot to tell you that did they?

And what if you’re the seller?

Your buyer stops making payments six months after the sale closes. It’s you the lender will hunt down like a dog. They couldn’t care less about your buyer. Your John Hancock is on their note and that’s who they’re gonna hang.

Say goodbye to your perfect credit history if you had one.

Oh, and by the way? Your note surely contained language forbidding what you did. Yeah — what thought just went through your head? Oh #^%$&*! Exactly.

Pause here for a bit of the Way Back machine. Back in the late ’70’s and early ’80’s taking properties ’subject to’ was a blood sport for savvy agents. Each week a bunch of investment brokers got together, including one who’d later become bawld, and would swap the latest stories about pulling the wool over some lender’s eyes. Locally, the biggest feather was if you successfully took over a Home Fed loan. They were, at least in our opinion back then, Satan’s spawn. They’d take a property back from Grandma Walton if it suited them. You couldn’t buy a drink to save your life when the next time Happy Hour arrived.

Little remembered name in the history of all this: Cynthia Wellenkamp — who did us no favors. She was the borrower who started all the dominoes falling. She sued B of A for a lousy $13 and change a month in payment increase. Her case ultimately resulted in the legislation mentioned above. Geez, Cynthia — for $13 a month?

And what about those doing this as a way to buy a property currently in default?

Well, practically speaking the lender might be thrilled to death to learn somebody paid all the back payments plus their costs of initiating the foreclosure process. What with all the properties they’re having to take back, you’ve no doubt made their day.

On the other hand…

Let’s say you’ve saved up for quite awhile and found the perfect investment property — the owner has defaulted and is five months behind. You strike a deal for what he owes plus tickets back to his hometown. You take title ’subject to’ his existing financing. Very cool for you — instant equity. You immediately dive into fixing it up, as it’s been sadly neglected for at least a couple years. Now you’re into it for over say, $30,000 — give or take — after all, it’s just money, right? Right.

And that’s when the notice arrives. See, the current correction? It began losing steam, while interest rates began to climb slightly. Not much, just enough to make the lender look at your interest rate with evil thoughts. Their cost of funds is now too high to support the relatively low interest on the loan you took over. As soon as they decide that’s the case, turn out the lights, ‘cuz the party? She is over. From their viewpoint you’ve done them a great favor too. You fixed ‘their’ property up so it’ll sell without a loss.

You took title ’subject to’ no doubt ‘cuz you thought or knew you couldn’t qualify for new financing. If that hasn’t changed, you’ve just lost all your money.

Taking title ’subject to’ is a risk for which I would not — will not — be a party to — at least not as a real estate investment broker/advisor. I’m not telling you not to, just that I wouldn’t be a party to it. If you can’t qualify for a new loan, or you can but the property can’t, you’re dead in the water.

The risk assessment is up to you. If a client were to tell me they planned on using this technique, I’d ask them to please sign a letter — sporting my letterhead — saying how I strongly advised them not to. I feel that strongly.

That’s how seriously you should take this ’subject to’ heart.

Sorry — couldn’t stop myself in time.

This entry was posted on Tuesday, March 11th, 2008 at 12:42 am and is filed under Real Estate Investing, Selling Income Property, Buying Income Property, Market Correction, Investment Lessons. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.