I’ve been working with a client recently seeking to obtain a Luxury Property via ‘subject to,’ a method I have personally used to obtain real property. If you are not familiar with this method, learn it, and let it be another arrow in your quiver for helping Luxury Sellers in this challenging market.
In a ‘Subject To’ closing, the Seller quit claims the deed to their home to the Buyer in exchange for the Buyer taking over the mortgage payments. There is an agreed upon sales price, an attorney closing of the transaction, and contractual language which protects both Seller and Buyer.
Key advantages are the miniscule closing costs, and the speed of the transaction. This is a unique method of real estate transfer, and is absolutely not for everyone!
Why would a Seller not want to get paid in full at closing?
Virtually every Seller does! However, we see listings every day of properties which have been languishing on the market for months (DOM 365 sound familiar??). If a Seller must relocate, or due to layoff can no longer afford their mortgage payment, a ‘Subject To’ could be just what the doctor ordered!
Remember, the contractual language should protect the Seller from Buyer default, and the same language should protect the Buyer from Seller fraud.
Next time I’ll go into some depth about what should be included in the contract language.
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Not having a law degree can be liberating! That means that I will not provide the legal language that belongs in a ‘subject to’ transaction because it is not the lane in which I operate. I will confine my comments to those concepts and practical outworkings which belong in the language. But, again, that language is best written and defined by an attorney well-versed in all matters of real property law.
Immediately we see, or should infer, that a ‘subject to’ possession of real property interests is not something that should be done over the Kitchen table, unless the closing attorney who drafted the binding contractual language has made a house call!
Provisions, at the luxury level, which are spelled out in the contract should, as noted above, protect the Seller from Buyer default, and likewise protect the Buyer from Seller fraud. One such provision requires the establishment of a unique bank account when the subject property is still security for a mortgage held by the Seller. This bank account is unique in that deposits should be made only by the Buyer, and withdrawals should be made only by the Seller’s Lender.
Additionally, this account should have a minimum of two months of mortgage payments held in escrow as a first line of defense against Buyer default. The practical outworking of this safety measure is found in the very real world in which we live. Should the Buyer hit a difficult spot resulting in their payment being a day or so late, the credit of the Seller is not adversely affected because the Lender will have drafted the account for the payment on the first day of the month. The Buyer makes the deposit into the agreed upon account, albeit a couple of days after the fifteenth, but the draft has already gone.
In this scenario, the Buyer owes no late fee, the mortgage remains current, and the Seller’s credit is strengthened by another on-time payment. The Buyer must now return the payment to restore the escrowed buffer. Here is where properly written contractual language will further protect the Seller. While it is true there will be no late payment assessed the Buyer for making the payment after the fiftteenth, the fact of the matter is escrow has been reduced to cover what would have been a late payment. For the escrow to be restored fully, the Buyer will not only have to make the payment, late or not, but will have to make another payment on the first of the next month.
Provisions in the contract should necessarily, therefore, provide triggers for the return of the deed to the Seller in the event of Buyer default. I suggest one such trigger is found in this hypothetical reduction in the escrow. Buyer should have a certain number of days to restore escrow, or penalties will be assessed. The blessing of a ‘subject to’ transaction which creates a win/win enjoyed by both parties (Seller no longer pays the mortgage, property taxes, maintenance, etc., and Buyer gets the deed and a home with little or no down payment) cannot continue in the face of Buyer default. The return of the deed to the Seller is a foreclosure mechanism, and it must not only be present, it must be almost immediate.
The presence of escrowed mortgage payments to guard against Buyer default must be present to protect the Seller’s credit. The Buyer, in the presence of his or her faithful execution of their obligations under the agreement, must also have the covenant of quiet enjoyment. However, the Buyer, until the mortgage has been paid in full, must maintain the property in as good or better condition than that in which he or she originally took possession.
When a Buyer in a ‘subject to’ transaction receives the warranty deed at the ‘subject to’ closing, they have control of the property. They may sell it, they may refinance it to pull cash out, and they may obtain a mortgage on the deed. All the while, they must also continue, day by day, to make the Seller whole either through payments directly to the Seller, payments directly into a Lender-drafted escrow account, or a combination of both. Integral in continuing to make the Seller whole is the mandate that the property’s value be maintained at a high level.
The property remains the security for the Seller’s mortgage. If the agreement provides for the Seller’s mortgage to be paid in full upon the sale of the property, or to be paid in full when the Buyer obtains a mortgage of his or her own using the deed as security, the sale or new mortgage must be sufficient to make the Seller whole. It should not be the intention of a ‘subject to’ possession to have a Seller hold a mortgage for the life of that loan. The point for the Seller in a ‘subject to’ is to get out from under the mortgage more quickly that would be possible normally or in the absence of a traditional sale. Meanwhile, the point for the Buyer is to get into the property inexpensively. The goal of the Buyer must be to pay off the Seller’s mortgage as quickly as possible, and to keep the Seller’s property in saleable condition until that has occurred.
You may ask, but what about protecting against Seller fraud? This is accomplished as soon as responsibility for the Lender’s receipt of a timely payment is taken from the Seller and put in the ‘hands’ of the escrowed bank account. The Buyer then can have assurance that the Lender is receiving their payment. You see, even though the Buyer has the deed to the property, as is the normal case following a closing, the Seller’s lender continues to have foreclosure power since the subject property is still security for that debt.
The worst case scenario for an honest Seller is a dishonest Buyer who pulls cash out of the property using the deed and then walks away. The worst case scenario for an honest Buyer is a dishonest Seller who takes the Buyer’s mortgage payments and pockets them. The language in the agreement which binds these parties together must become the mechanism by which this transaction runs to the benefit of both Seller and Buyer helping them to remain honest.
