Instagram Reels, TikTok, YouTube Shorts - these videos are all so addicting. Watching 30 second to 3 minute videos feed our dopamine receptors making us feel GREAT. Going down a social media rabbit hole can feel fun and exciting. As a Realtor, I am dished up a plethora of captivating videos regarding home renovations, home inspections, mortgage info, you name it. Some of them are "get rich quick" schemes. I watched one of these videos and the algorithym immediately presented five or six more in quick succession.
"I bought this $3 million dollar home with no mortgage, no credit checks and a sub 3% interest rate, and you can too" the slickly dressed millennial boasts in that loud, borderline obnoxious tone designed to capture our full attention.
After watching a few of these videos advertising the same scenarios, I started to pay a little more attention to the content. What, exactly are these "real estate gurus" actually selling? Why, a "system" of course - their own proprietary method guaranteed to make you money. The catch phrase that all of these videos have in common is "subject to" -
I bought this property subject to with no money down, a sub 3% mortgage, no credit checks, and you can too.
Taking a property subject to means that the property ownership is transferred, usually via simple instrument like a quitclaim deed, that does not remove the existing mortgage. In a typical residential real estate purchase the buyer purchases the property with their own financing, and the seller delivers title via a warranty deed and the title/escrow company facilitating the purchase pays off all existing liens (and mortgages) prior to closing. The buyer must bring either the full purchase price to closing, or secure their own financing at then current rates and conditions. Because the mortgage rates are much higher today than they were just over a year ago, consumers are desperately looking for creative ways to carry over an existing low interest rate mortgage. The buzzword six months ago was "assumable". Yes, some lenders and mortgage products technically allow for a buyer to assume the existing mortgage. Lenders were touting this as a legitimate option failing to mention a few particulars - first the buyer still needed to qualify for the existing mortgage, the lender had to approve the assumption, and the previous owner would need to be released from the liability of the mortgage. Most importantly, the buyer has to pay cash or get creative financing for the equity the seller currently has in the property. Consider this fact pattern:
Seller purchased a property five years ago for $350,000 with an FHA (assumable) mortgage and 5% downpayment. Seller makes the standard amortized monthly payments lowering the total borrowed amount to ~$295,000. Seller has gained an additional $200,000 in equity from market appreciation. Seller wants to sell the property for $550,000. Buyer wants to assume the remaining mortgage of ~$295,000, meaning the buyer must come up with an additional $255,000 in cash to pay the seller.
As buyers realized all of the hurdles they would have to jump through to make this work, the talk of assumable loans has mostly gone away.
The difference between subject to and assumable is that the loan doesn't get paid off or transferred, in fact the bank does not hear about the sale at all, because if they did, they have the right to exercise their "due on sale" clause and immediately call the loan. Furthermore, the seller transfers ownership of the property (the asset), while still remaining fully responsible for the mortgage (the liability). An agreement would also need to be made between the seller and the buyer regarding who will pay the mortgage (will the buyer pay the seller and the seller pay the mortgage, or will the buyer make the payments directly to the lender). And remember, the seller still must be paid their equity, which could be done in a lump sum payment or by paying monthly installments.
So if the buyer stops making payments, the seller would have to continue to do so or risk foreclosure. And if the agreement is structured so that the seller pays the mortgage, and doesn't, the buyer risks foreclosure and wiping out their equity. Or the seller's lender issues a notice-of-payment-due-in-full because they find out the property changed hands triggering their due-on-sale clause. All of these risks remain for the entire term of the loan, which could be for possibly 30 more years.
The level of risk for all parties is monumental, and all because the buyer wants to avoid paying market rate for their mortgage.
So, obviously this is a really dumb idea. It's not remotely worth the risk. The biggest reason this borders on fraud is because the seller can't possibly know how risky this type of deal structure is, or they wouldn't do it.
But this scam didn't just come out of nowhere. These subject to scenarios took off during the great recession as a way to avoid foreclosure:
An investor would locate a distressed property owner, they would pay the back payments the owner owed the bank in exchange for the title via quitclaim deed subject to the existing mortgage (technically speaking a quitclaim deed always transfers title subject to all liens and encumbrances, so the subject to wording is more of an estoppel than anything else, but buzzwords sell and the buzzword is subject to - can you hear my eyes rolling??). In some cases the seller would continue to live in the home and make rent payments to the investor and the investor would hold the property until the market appreciated enough to sell, or the seller moved out and the investor would improve the property and flip it for a profit.
The seller avoids foreclosure and the investor makes money. A "win-win". And I'm sure that worked for some people. However, and I can't stress this enough, whether you are a seller or investor, you must understand the risks involved with any of these investment strategies. As an investor, you need to know how the seller can still jeopardize your investment, and you must have a strong background already in real estate, especially if you are going to fix/flip the home. And you must have the cash on hand to carry the costs if the home takes longer than anticipated to sell. This form of investing is not a "went to a weekend seminar and now I'm ready to dive in" sort of thing. Across the board, you will lose all of your money.
Of course there is a lot of money to be made in real estate, we all know that. However, if you do not have the money to risk, and the skill set necessary to take on these projects, your real estate investing should remain solely on a "buy and hold" strategy.
Regardless of your strategy and skill level, having a conversation with an experienced real estate broker will help you develop a safer investment plan. I offer a free hour long consultation. Reach out if you want to discuss these strategies one on one.