What is Subject To Mortgage?

Subject To Mortgage is a term used in real estate to describe a transaction in which a buyer purchases a property "subject to" the existing mortgage on the property. In such cases, the buyer takes over ownership of the property and assumes responsibility for making mortgage payments, but the original borrower remains liable for the loan. This arrangement allows the buyer to acquire the property without having to qualify for a new mortgage or obtain financing, but it also carries risks for both parties and may not be permitted by all lenders or mortgage agreements.

A subject-to mortgage arrangement is a financing method where the buyer takes over the existing mortgage payments of the seller without formally assuming the loan. In this arrangement, the mortgage remains in the seller's name, but the buyer gains control of the property and makes the mortgage payments. This type of arrangement can be advantageous in certain situations, but it also carries risks for both buyers and sellers.

How a Subject-To Mortgage Arrangement Works

1. Agreement: The buyer and seller agree on the terms of the subject-to mortgage arrangement. The buyer agrees to take over the seller's mortgage payments, while the seller transfers the property title to the buyer.

2. Title Transfer: The property title is transferred to the buyer, but the existing mortgage remains in the seller's name. The buyer gains control of the property and takes responsibility for making the mortgage payments.

3. Payment Responsibility: The buyer makes monthly mortgage payments directly to the lender. In some cases, the buyer may also pay an additional amount to the seller if the agreed purchase price is higher than the remaining mortgage balance.

4. Continued Obligation: The seller remains legally obligated to the mortgage. If the buyer fails to make payments, the seller's credit and financial standing are at risk.

Risks for Buyers

Due-on-Sale Clause

One of the primary risks for buyers is the due-on-sale clause found in most mortgage agreements. This clause allows the lender to demand full repayment of the loan if the property is sold or transferred. Although lenders may not always enforce this clause, the risk remains that the lender could call the loan due, requiring immediate payment in full.

Credit Impact

While the mortgage remains in the seller's name, the buyer's credit history is not directly affected by the mortgage payments. This can be a disadvantage if the buyer is looking to build credit through mortgage payments. Additionally, if the buyer defaults on payments, it does not impact their credit, but it can strain the buyer-seller relationship and potentially lead to legal issues.

Property Liens

Buyers need to be aware of any existing liens or encumbrances on the property. Taking over a mortgage subject-to does not clear any previous liens, which could lead to complications if the buyer is unaware of these issues at the time of purchase.

Risks for Sellers

Credit Risk

The most significant risk for sellers is the potential impact on their credit if the buyer fails to make mortgage payments. Since the mortgage remains in the seller's name, any missed payments or defaults will negatively affect the seller's credit score and financial standing.

Legal Liability

Despite transferring the property title to the buyer, the seller remains legally liable for the mortgage. If the buyer defaults, the lender may pursue the seller for payment, leading to potential legal and financial complications.

Difficulty in Obtaining New Financing

Having an existing mortgage in their name can make it challenging for sellers to obtain new financing for another property. Lenders consider the existing mortgage when evaluating the seller's debt-to-income ratio, potentially limiting their borrowing capacity.

Mitigating Risks

Formal Agreements

Both parties should have a formal agreement outlining the terms of the subject-to arrangement, including payment schedules, responsibilities, and remedies for default. This agreement should be reviewed by a real estate attorney to ensure legal protection for both parties.

Communication with the Lender

While the arrangement is subject-to the existing mortgage, it is advisable to inform the lender of the transaction. Although this may trigger the due-on-sale clause, transparent communication can sometimes lead to lender cooperation or alternative arrangements.

Escrow Services

Using an escrow service can provide additional security. The buyer makes payments to the escrow service, which then forwards the payments to the lender. This arrangement ensures that payments are made on time and provides a record of transactions, protecting both parties.

Understanding the mechanics and risks of a subject-to mortgage arrangement is crucial for both buyers and sellers to make informed decisions and safeguard their financial interests.