How subject-to real estate deals work, with an example

What a subject-to deal is

Subject-to means you buy a house subject to the existing financing. The seller deeds the house to you, but their mortgage stays exactly where it is, in their name. You do not get a new loan, and the lender does not approve you. You make the payments on the seller's loan because you now own the house.

That is the whole appeal and the whole risk in one sentence. You can get a house with a low-rate loan and little cash, but the loan is not yours, the seller is still on the hook, and the lender keeps the right to demand the full balance.

Subject-to is different from assuming a loan. In a formal assumption the lender approves the new buyer and usually releases the seller—model that path with the assumable mortgage calculator. In a subject-to deal nobody asks the lender, so the seller is not released.

How the money moves

At closing, the price is split into pieces. Most of it is the loan balance you take over. If the seller is behind, part of the price goes to the lender to bring the loan current. Whatever is left is the seller's equity, paid in cash, or sometimes carried as a note.

After closing, you collect the rent and pay the seller's loan every month, ideally through a licensed loan servicer or escrow company so both sides can see every payment. You also pay your own insurance, the property taxes if they are not escrowed, repairs, and everything else an owner pays.

Your cash to get in is the cash to the seller, the arrears (past-due payments), closing costs, and any repairs. That small number is why cash-on-cash returns on subject-to deals can look high. It is also why a called loan hurts so much: there is little equity cushion of your own if you need to refinance at today's rates.

Formula

Debt today = loan balance + arrears. Cash to seller = price − debt today. Cash to get in = cash to seller + arrears + closing costs + repairs.

PITI = principal and interest + monthly tax + monthly insurance. Monthly cash flow = rent × (1 − vacancy) − PITI − other monthly costs. Cash-on-cash = yearly cash flow ÷ cash to get in.

Rate edge = payment on the same balance at today's rate over 30 years − the existing payment. Exit profit = sale price − selling costs − loan balance at sale + all the cash flow − cash to get in.

Example

Illustrative example. These are the same sample numbers the subject-to calculator opens with. They are not a real property, seller, or deal. A house is worth $300,000. The seller owes $230,000 at 3.25% with 25 years left and is $6,000 behind (arrears, or past-due payments), so the debt today is $236,000 and the seller's equity is $64,000. You agree on a $250,000 price.

Cash to get in: $14,000 to the seller, $6,000 to bring the loan current, $4,000 of closing costs, and $6,000 of repairs, for $30,000. You start with $70,000 of equity ($300,000 value − $230,000 loan), and the price is $50,000 under value.

Monthly: the existing principal and interest is $1,120.83. Add $250 of property tax and $150 of insurance and the PITI is $1,520.83. Rent of $2,400 with 5% vacancy brings in $2,280. After the PITI and $300 of other costs, the house cash flows $459.17 a month, or $5,510.04 a year. Divided by the $30,000 to get in, that is an 18.4% cash-on-cash return.

The rate edge: the same $230,000 borrowed new at 7% over 30 years (a sample rate for an investor loan; check today's quotes and type yours in the calculator) would cost $1,530.20 a month, $409.37 more than the existing loan. That gap is most of the cash flow, which is exactly why the deal depends on the old loan staying in place.

The exit: hold 5 years at 3% a year and the house is worth about $347,782. Selling costs of 7% are $24,345, and the loan is down to $197,608, so the sale nets $125,829. Add $27,550 of cash flow over the 5 years and subtract the $30,000 you put in, and the profit is $123,379 before income tax. Most of that is equity, not cash flow: $40,000 is equity you start with because the price is below value, $47,782 is appreciation, and $32,392 is loan paydown. The cash flow is $27,550.

The seller's side: listing the house at $300,000 with 7% selling costs and paying off the $236,000 debt would net the seller about $43,000, versus $14,000 in this offer. A seller who can wait and list may do better. A seller facing foreclosure may not have that time. Either way, put both numbers in writing for the seller, tell them listing is an option, and recommend they have their own attorney review the deal before they sign. In many states, buying from an owner in foreclosure without these protections breaks the law. Do not pressure a seller who is behind on payments.

The due-on-sale clause

Most residential mortgages say the lender can demand the whole balance if the property is sold or transferred without its consent. The Garn-St Germain Depository Institutions Act (12 U.S.C. 1701j-3) generally lets lenders enforce that clause. The law lists exceptions, such as a transfer to a spouse or child, or into a living trust where the borrower stays a beneficiary and occupant, but a sale to an investor is not one of them.

Lenders do not always call loans that are paid on time, but nothing stops them, and no one can promise they will not. If the loan is called, you need to pay it off, refinance at today's rates, or sell. Run the subject-to calculator at today's rate before you buy to see whether the house still works that way.

The seller's credit, insurance, and escrow

The loan stays on the seller's credit report. If a payment is late, their score drops, not yours. The balance can also count against them when they apply for their next mortgage. A servicer, a written agreement, and a plan for what happens if a payment is missed protect both sides.

The seller's homeowner policy usually does not fit once they move out and you own the house. You need your own coverage, usually a landlord policy in your name, with the lender as mortgagee and the seller added as an additional insured, if your attorney and insurer agree. Be truthful with the lender and the insurer about who owns and lives in the house. Settle the seller's escrow balance and any escrow shortage at closing, and expect the tax and insurance part of the payment to change over time.

State rules and who to hire

Some states regulate or restrict subject-to purchases, especially from owners who are behind on payments or in foreclosure. California's Home Equity Sales Contracts Act (Civil Code section 1695 and following) and the Colorado Foreclosure Protection Act (C.R.S. 6-1-1101 and following) are two examples of equity purchaser and foreclosure rescue laws with required contract language, cancellation rights, and penalties. Other states have their own rules, and they change.

Hire a real estate attorney in the property's state to draft the agreement and a title company to search title, record the deed, and close. If the seller carries a note for part of their equity, federal loan originator and ability-to-repay rules (Dodd-Frank, the SAFE Act) and state licensing laws can apply too, including on wrap deals. Not legal, tax, or financial advice.

Common pitfalls

Underwriting on the principal and interest alone. The escrowed taxes and insurance can rise every year, and a landlord policy usually costs more than the seller's old homeowner policy.

Keeping no reserve for a called loan. The low rate is what makes the numbers work, so set aside cash and know your refinance or sale plan before you need it.

Letting payments go straight from your account to the lender with no record the seller can see. Use a servicer so every payment is documented.

Pressuring a seller who is behind on payments. Equity purchaser laws in several states exist because of that exact situation. Give the seller time, the numbers, and room to get their own advice.

Sources

Due-on-sale enforcement and its exceptions: Garn-St Germain Depository Institutions Act, 12 U.S.C. 1701j-3, and the federal rule at 12 CFR Part 191. California equity purchaser rules: Home Equity Sales Contracts Act, California Civil Code section 1695 and following. Colorado: Colorado Foreclosure Protection Act, C.R.S. 6-1-1101 and following.

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