The Current Market
The real estate market is ever changing and evolving. In the current environment of high property values and increasing interest rates, people are understandably trying to find creative ways to get into a home. Purchasing property using “subject to” assumptions seem to be the latest and greatest strategy. The general concept of assuming a sellers existing 3% loan is far superior to getting a new loan at 7%. The difference being the amount of down payment required to purchase.
What is a Subject To Assumption?
Our purpose here is to understand what a subject to assumption truly is, and the potential hazards involved with this type of home finance. Assuming a loan “subject to” means the buyer is not liable for the debt (payments) but rather the seller remains responsible for the payments after the sale.
In a true assumption the buyer “assumes and agrees to and pay” the debt, and the seller generally requires a release of liability from the lender. The lender must also approve the assumption including the buyers credit credentials before the assumption is allowed.
Whether any assumption is allowed by the lender depends on the wording of the Trust Deed (the loan document that places the property as collateral for the loan). Many Trust Deeds contain an “alienation” clause that requires the loan to be paid in full if the owner sells or gives away the property, this would be a loan that is not assumable, typically a conventional loan. If an assumption is allowed, lenders require the buyer to assume and agree to pay and, if the buyer is well qualified, the lender may agree to release the seller’s liability for the loan. Either way, lender knowledge and approval is required.
The Issue with Subject To Assumptions
The real problem with subject to assumptions is they are accomplished without the lender’s knowledge or approval. Being informed, the lender will not approve a subject to assumption. Therefore, selling or buying property subject to cannot be accomplished with lender cooperation and is therefore considered loan fraud which is a felony.
So, the bubble is burst, subject to assumptions are fraudulent unless the lender is informed and agrees. Lack of lender approval subjects the buyer, seller, and broker to felony charges.
But the story does not end there. The last time the market was experiencing high loan interest rates, in the 1980’s rates were as high as 18-21 percent, buying subject to became popular. The buyer purchased subject to, typically rented the house, pocketed the rent, and never made a single loan payment. The property eventually went into foreclosure. The rub here is that the foreclosure was against the seller as they remained liable for the debt, including any deficiency judgement. The buyer is guilty of “equity skimming” and the seller ends up in court. People went to jail, including the brilliant real estate brokers that facilitated this activity!
In conclusion, buying subject to is a great idea, except no lender would allow it. It is this authors opinion that if one wants to play the subject to game, they should keep their personal assets in an offshore account and have an open plane ticket to a non-extradition country in their hip pocket.
Another dynamic that you might hear about today, related to subject to assumptions, is wrap around mortgages. We will discuss this dangerous strategy in subsequent blog posts.