In Part 1 of this series on how to transact Subject To deals, I explained exactly what is Subject To investing and how you can both profit from them and help a distressed homeowner as well.
Part 2 outlined the risks and benefits of entering into a subject to transaction that affect not only you, but also the seller, and how to mitigate them.
In this post, I break down the steps necessary to a successful Subject To real estate deal, from verifying seller facts to closing.
The steps to acquire a property Subject To an existing mortgage are:
- Perform initial due diligence on the seller and property
- Verify the facts
- Determine your exit strategy and offer
- Prepare your purchase documents
- Finalize the transaction
- After the closing
Let’s start with the first step, the initial contact.
Perform initial due diligence on the seller and property
When you first get a distressed seller lead, the first step is to perform a through due diligence of that seller’s situation, and determine the condition and value of the property.
In this section I cover: what information to get from the seller, determining a property’s value, what you should take with you when you visit the property, how to get the facts from the lender, and other information you will need to obtain, to evaluate a deal and determine your offer.
First, get the facts from the seller
Prior to stepping foot on the property you need to understand the seller’s situation. You will want to find out not only the reason for their distress, but also their level of motivation.
With the seller on the phone, or in person, ask them who their mortgage lender is, how many payments they are behind on, what the latest mortgage payment amount is, the current loan balance, and any known arrears or liens on the property, such as tax liens or mechanics liens.
If you are speaking with the seller in person, you can ask them to sign an Authorization to Release Information form that will give you the ability to verify the information they gave you with their lender.
This will be one of the documents described in the next post about the documents necessary for a Subject To transaction.
Now that you have the seller’s facts, it’s time to calculate the property’s After Repair Value (ARV), or what the property would sell for on the open market after it has been rehabbed.
Determine the After Repair Value
There are a two major parts to determining the property’s value.
The first is to select appropriate rehabbed comps that are within the same neighborhood, that sold recently, and that are as much like the property that you are looking at.
The second part is to perform a thorough sales comparison analysis, adjusting those comps for feature values such as beds, baths, garages and pools.
This guide explains exactly how to do that, by finding comps and adjusting them to accurately calculate ARV:
You will need to make sure that you take your exit strategy into account when you are determining these adjustments.
For example, if you are intending on rehabbing the property for resale to a homeowner, then you will want to look at recently rehabbed properties for valid comparison. On the other hand if you will be renting the property out, or using a lease option strategy, then it may be better compared to other rental properties in the area.
Get your initial documents signed
One of the first documents that you will need to get the seller to sign in order to perform more in-depth fact checking is the Third-Party Authorization to Release Information form, which will allow you to contact the seller’s lending institution and creditors.
This form should be readily available on the lender’s website or search online for it using the words Third-Party Authorization to Release Information + lender’s name.
You should get your seller to sign this form via DocuSign or using any other electronic signature platform, which will save you a ton of time in performing your lender due diligence.
If you can’t get this done electronically, you should bring this form with you when you visit the property.
Visit the property
So far, you understand the seller’s financial position and motivation, and you have the property’s ARV.
You’re still missing a big piece of the puzzle, and that piece is the repair items that you will find when you visit the property.
Determine the repairs necessary
When you visit the seller’s home, you’ll need to walk the property and note any needed repairs.
Personally, when I first walk a property I get so excited with the potential of a deal, that if I don’t have a checklist with me, I always forget to identify half the necessary items.
This is why I use this Rehab Walkthrough Estimation Checklist link to keep me focused on noting the condition of the property, making sure that I account for all of the major systems that may or may not need to be repaired.
Additionally, if you don’t know what to look for, you should consider picking up a copy of this book, used by home inspectors to prepare for their exams:
The NHIE Home Inspection Manual
Determine the cost of repairs
Once you have noted the repairs that need to occur, you should estimate their costs.
If you have never estimated rehab costs before, then here are a number of resources available to you that will get you a long way to doing so:
First, if you haven’t already, you should read this post from the Flipping Guide:
Next, in the Resources menu, I list several books that you should read. Specifically you should have already read:
J Scotts Book on Estimating Rehab costs
Verify the facts
The next step in the process is to verify all of the information that the seller has told you.
Get the facts from the lender
With your signed Third-Party Authorization to Release Information form, call the lender, who will ask you to email or fax the form to them before they let you discuss the seller’s account.
You will want to request the history of the loan, the balance remaining, any arrears, escrow balance, and payoff documentation.
Once you have received the information from the lender, compare it to what the seller provided to you to make sure that the information matches up. If there are differences between the lender’s current information and the seller’s information, such as the number of months behind on payments, payment amount and so on, make note of them so you can properly calculate your offer.
Run a title search
Perform a preliminary title search, or have a title company do a preliminary search, to fully understand who are all the owners of the property, and the chain of title. The title search will reveal any other liens or taxes on the property, such as Federal IRS Liens, Tax Liens, Mechanics Liens, HOA Liens, or Code Enforcement Liens, among others.
Check owed balances on utilities and property taxes
The seller’s water, electric, sewer, and other utilities accounts as well as alarm companies and the like can have existing balances owed. When utilities are behind and get sent to a credit-reporting agency, there may also be a lien on the property for the amount.
You should call all of the utilities to make sure the payments are current.
Also check the property tax amount, which is usually public record and can be found online using the Assessor’s Parcel Number or some other identifier, and that property taxes have been brought up to date, or note when the next payment is due.
With the seller’s current liabilities, the property’s ARV, and the estimated repair costs written down, you’ll have a rough estimate of what kind of deal you’re looking at.
Identify potential costs
Next let’s talk costs, specifically your costs when it comes to executing a Subject To transaction.
While Subject To is often touted as a ‘no money required’ strategy, there are many cases in which you’ll find that you do need some funds to carry the property.
For example, you many need money to:
- Pay off arrears on the mortgage to get it caught up
- Pay seller part of their equity in the property
- Pay closing costs such as:
- Closing attorney
- Transfer fees or taxes
- Escrow fees
- Title insurance
- Make the payments after you’ve transferred title and are looking for a buyer
Once you have identified all of those costs, you can start to formulate your exit strategy and draw up your offer.
Determine your exit strategy and offer
It is the seller’s financial situation that will determine your available exit strategies, and thus the details of the offer.
Although I devote the final post to showing a few examples of seller situations and how those will impact your exit strategies, for now you can begin thinking about the following basic situations. These will guide you as you start formulating your exit strategies to create a win-win offer that gets the seller from under the house, and makes sure that you profit:
- In some cases, you can take title to a property Subject To, without putting up any of your own money. In fact, in situations where the seller is behind on payments, they may agree to catch up the loan before transferring the deed.
- If the seller owes more than the property is worth, you could negotiate that they give you money to take a problem property off their hands.
- In many cases, you may need to pay the seller. This could be, for example, to pay for some of their equity in the property, if they owe less than what the property is worth.
You can review your potential exit strategies in the first post, to see how each of these situations will have an impact on your exit strategy, and your offer.
Prepare your purchase documents
As with most things involving the law, the basics of contracts would take up several chapters, so I will not go into those here. I will, however, go into detail about some of the most important documents that you will need as part of your purchase, in the next post.
Specifically, you will need a purchase agreement that is valid and enforceable in your state.
For this reason, I strongly recommend that you always have your Subject To contracts and documentation created by a real estate attorney in your jurisdiction that is also familiar with Subject to transactions.
In general, your purchase contract will serve two major purposes:
- To present the offer and exchange of value to your seller
- To disclose, disclose, disclose the risks to the seller
In the next post, I will go into more detail about the major clauses that you should have your attorney include in your contract, especially the disclosure of your intent to make a profit, and the risks of the due-on sale clause.
If your offer is accepted, now it’s time to close.
Finalize the transaction
Title company, closing attorney, or the kitchen table?
Every state has different laws as to how to close real estate transactions. Some require a title company, others require an attorney at close, some allow you to close at the seller’s kitchen table, and some allow all of those closing methods.
If you are just starting out with the Subject To strategy, I don’t recommend kitchen table closings, even if they are valid in your state. You’ll want to close using a closing attorney or through a title company; find out which (if any) might be required in your state.
This PDF from First American Title, shows a good outline of some of the documents and costs that you may need in each state and whether an attorney is required at closing:
In general, of the documents that will be required for closing, some will be recorded, and some you will keep for your records. Most documentation will need to be signed by the sellers, some will need to be notarized, and others just witnessed.
If the seller is married, you should always make sure that the spouse signs all of the documents.
A great title company or attorney that is well versed in these transactions will guide you through the closing process from A-Z and smooth out any bumps. There are always bumps.
You might find when you first start calling around for a title company, that many do not understand how to process a Subject To. The only difference between a traditional closing and a closing Subject To is that the lender is not receiving a payoff and there is no new mortgage being prepared for you, the buyer, and so the title is encumbered with the original financing.
Some title companies will not perform a Subject To transaction, period, while others do them frequently, so you may need to call several to find one that performs these.
Your title company does matter, so try to have this in place before you start marketing for sellers. Ask for company recommendations at Real Estate Investment Clubs in the areas where you are finding motivated sellers.
What happens after you close and your documents are sent for recording?
After the closing
Once the transaction is complete you’ll need to do the following:
You should have exchanged these at closing. You’ll need to make sure that the seller gives you any keys and garage door openers as well as any alarm codes. After closing, you’ll need to get a locksmith to re-key all of your doors.
Cancel seller’s insurance.
Using your Limited Power of Attorney, cancel the seller’s homeowner’s insurance policy, but make sure you change the mailing address to your address before canceling.
This will ensure that you, and not the seller, will get proceeds should the seller make a claim against the property. Alternatively, you can, at closing, have the seller sign a letter of insurance cancellation, requesting that any unearned premiums be sent to your or your company’s address.
Obtain your own insurance.
You will need to create a new policy, specifically a non-owner occupied landlord policy. You will want to be listed as the first named insured, with the existing mortgage company as the mortgagee. Add the seller as additional insured.
Our insurance provider (NREIG), recommends that you should always have your own policy on the property to avoid a denied claim because the primary insured is no longer the owner.
Change of address and phone number.
If you are sending the lender a letter informing them of the title transfer, request that the seller sign the change of address form from the lender, making your address the new billing address, as well as your phone number.
Lender’s Online Payment Information
Get the lender’s online payment methods, such as a payment portal, or any applicable paper methods so that you can begin to make payments.
Subject To agreements can seem complex on the surface, but the steps needed to execute this creative method of investing in real estate are fairly straightforward. In this post I covered how to vet information from the sellers, a summary of how to perform due diligence on the property, where you should perform the closing, and what to do after the closing.
In the next part, I’ll talk about the specifics of the Subject To purchase agreement, and some of the most important disclosure items to include, so as to keep you out of trouble.