Subject To Deals | A Dangerous Predator | Ross Law

This article was originally published in the NABOR E-Newsletter. You can view a copy of that here.

Subject To Deals | A Dangerous Predator
Designed to look victimless, these transactions are anything but.
By: Christian Ross, Esq. and Kevin Lottes, Esq.

For as long as there have been mortgages, there have been people trying to avoid paying them off.
More recently, due in part to high interest rates and lender fees, Buyers are proposing that they buy the
Seller’s property “subject to” the existing mortgage staying in place. But, is that even legal?

The Deal | Typically born out of the Seller’s desperation to sell the property, a subject-to Buyer would
propose that they pay out the Seller’s equity and possibly cover closing costs. After closing and upon
taking possession, the Seller and Buyer would agree that the Buyer would begin making the mortgage
payments on the Seller’s mortgage and execute their plans to rent or rehabilitate the property. Though
it’s possible, most Buyers in these transactions do not live in the property personally.

For example, a $250,000 property may have an existing mortgage of $200,000. The Buyer would pay
the Seller $50,000 at Closing and leave the existing mortgage in place. The Buyer’s title commitment
would include an exception to the existing mortgage.

Of note, the Closing Agent (i.e. Title Company or Law Firm) may refuse to handle this type of
transaction. Ross Law | Ross Title and Lottes Law Group, owned by the authors of this article, regularly
advise customers not to agree to these transactions.

The Lender | Though not illegal, buying a property without paying off the Seller’s pre-existing mortgage
would violate the terms of the “Due On Sale Clause” of the existing mortgage. The “Due On Sale
Clause”, which exists in nearly all Florida mortgages, states that the Borrower (Seller) must pay the
loan off in full upon the partial or full conveyance of the property to a third party.

Only a few limited exceptions would apply to this rule, such as conveying to the Borrower’s Trust, their
spouse, or a conveyance subject to a divorce or death. Though loan assumptions are possible for a
limited number of loans (i.e. FHA, VA), these types of deals do not contemplate getting the lender’s
permission.

Lenders are getting better at detecting these transactions and will often alert the Borrower of their
default quickly. Lenders will perform annual audits on their loans, reviewing insurance, taxes, and
ownership records, during which they will flag these violations and notify the Borrower. Failure to rectify
the default would lead to the lender initiating foreclosure.

The Seller | As you can imagine, these offers can initially be very intriguing. The Seller’s main focus is
in getting their equity at closing, and the expectation that the Buyer will pay the mortgage seems great.
However, the Seller is taking the most risk of anyone by purposely violating the terms of their loan and
being in default.

Best Case. The Seller’s credit report will still show the existing mortgage, including any late
payments or non-payments. Fannie Mae / Freddie Mac dictates that a new lender may ignore
the mortgage after the subject-to Buyer has made at least twelve (12) payments on the loan,
like underwriting for rental properties. If the payments continue to be made, the existing
mortgage won’t negatively impact the Seller’s debt to income ratio for the new loan.

Worst Case. The Seller may subject themselves to foreclosure, negative credit reporting, and a
deficiency judgment – even if the Buyer makes all the payments!

To make matters worse, the Seller has very limited solutions to rectify this default as they no longer
own the property. Even assuming the Buyer is willing to help resolve the default, the Seller may have to
reverse engineer the closing and return closing proceeds.

The Buyer | It’s a good deal for the Buyer, as they can keep their costs low in hopes of maximizing
potential returns. In the scenario above, the Buyer can purchase a $250,000 property for only $50,000
and without personally guaranteeing the new loan.

But life happens. Even assuming every Buyer has the best of intentions, problems could arise if the
Buyer has health issues, the rehabilitation goes over budget, or the real estate market experiences a
significant downturn. In the first six months of 2024, Florida alone has over 8000 foreclosure filings
wherein the Borrower was having trouble paying the mortgage or otherwise violating the terms of the
loan. Subject-to transactions are not immune to these risks, and might even experience higher rates of
default than a typical borrower due to the lack of a personal guarantee.

Even if the Buyer is just one day late on a payment, the Seller’s credit will be damaged while the Buyer
only pays a small late fee (individual loan terms vary).

If the Seller (as the original borrower) files for bankruptcy, this can also adversely impact the “subjectto” arrangement between that parties and the status if the property.
Also, it can be significantly more difficult for the Buyer to obtain insurance on a “subject-to” property.

The Realtor | Realtors have an obligation to present all offers to their customers, which includes
subject-to transactions (NAR Standard of Practice 1-6). Please be careful when doing so, however, as
they may not be in the best interest of the customer.

Want another example while it may not be a good idea? See if the subject-to Buyer even asks for
copies of the loan documents… they won’t, because they don’t care. They just want to know how much
is remaining, the monthly payment, and whether that could change.