What Is The Difference Between A Subject-to Loan And Loan Assumption?

What Is The Difference Between A Subject-to Loan And Loan Assumption?


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Traditional mortgage loans are not always possible, or favorable in the world of real estate.  Two of the most common ways of circumventing this is to purchase a home with a “subject-to” loan or by loan assumption.

When Would You Not Obtain a Traditional Loan?

For sellers, the most common reason for being in favor of one of these alternative means of selling a home is that they are behind on their payments.  When a seller is defaulting on a loan it can sometimes make the home more difficulty to sell because the existing loan must be made right before or at closing.  To do this, the past due amounts, as well as any penalties or fees owed, must be paid by the closing date.  Even more problematic is when a seller has very little or no equity in their home which can make it difficult or impossible to break even on the sale price.

For example: if a seller owes $200,000 on a house but the market value of the house is only $190,000, the seller would have to find a buyer willing to pay $200,000 for the home or he would still be responsible for $10,000 after the house has sold.  The seller would have to come to closing with $10,000 or make special arrangements, such as a short sale, with the lender.  It is highly unlikely that the seller would be able to find a buyer willing to pay $200,000 because, if the house only appraises for $190,000, the buyer can only obtain a loan for this amount meaning he would have to be willing to pay more for the house than it is worth and cover this amount in cash.

For buyers, these alternative means of buying a property can be beneficial when current interest rates are higher than the existing interest rate that the seller is paying.

For example: if the seller has a loan with an interest rate of 5% and current interest rates are 7% the buyer could save a significant amount of money.  For a $200,000 loan at 5% the monthly payment would be $1,073.64.  The same loan at 7% would be $1,330.60.  By taking over the current loan at 5% the buyer would be saving $256.96 each month.

Loan Assumption

Loan assumption is when the buyer “assumes” all responsibility and personal liability for the existing loan.  To do this, the seller must get approval from the seller’s lender.  Typically, the lender will want to run the buyers credit and have proof of appropriate income.  An assumption agreement is then drawn up by the existing lender and signed by the buyer as part of the escrow process.  This agreement will release the seller from any future financial liability for the loan.  If the current loan is delinquent, it must be brought current and any penalties or fees paid before the assumption is final.  The buyer will generally have to pay an assumption fee as well but this is typically much less than he would be paying with an increased interest rate.

Subject-to Loans

Short for “subject to the existing financing”.   In this case, neither the seller nor the buyer tells the current lender that the property has been sold.  Subject-to loans can be incredibly risky for sellers as the seller will continue to hold ultimate responsibility for loan payments.  The buyer and seller will sign an agreement and the seller will deed the property over to the buyer and the buyer will then begin making payments to the current lender.   The buyer is now the official owner of the property but the seller continues to hold the mortgage.   If the buyer becomes delinquent or defaults on the loan, it is the original seller who will have the financial consequences.

There are two main types of subject-to loans:

  • Subject-to cash-to-loan: This is the most common type of subject-to loan and is when the buyer pays cash to the seller for the difference between the purchase price and the balance of the loan and then begins making loan payments directly to the current lender. This, obviously, would only be the case if the seller does, in fact, have some amount of equity in the home. For example, if a house is purchased for $200,000 and the seller only owes $180,000 then the buyer would pay the seller $20,000 in cash and then take over loan payments.
  • Subject-to with seller carryback: This is also known as seller or owner financing. In this case, if a property is purchased for $200,000 and the seller owes $180,000 the buyer would begin making payments towards the existing loan of $180,000 at the seller’s current interest rate and the seller would carry the remaining $20,000.  The buyer and seller would then sign an agreement for the buyer to make payments, possibly at a higher interest rate, directly to the seller to pay off the $20,000.

A huge consideration that must be taking into account with subject-to loans is that the lender is not informed that the property is being sold.  Most mortgage agreements have a “due-on-sale” clause or acceleration clause.  These clauses state that when the property is sold, the balance of the loan is due to the lender.  For this reason, the lender is not notified of a subject-to loan agreement.  If the lender becomes aware of the sale of the property they have the right to execute these clauses and demand full payment of the loan immediately.  If the seller cannot payoff the outstanding balance, the lender then has the right to initiate foreclosure proceedings.

Because of the risk to the seller with a subject-to loan, it is not uncommon for the seller to request some kind of payment schedule so that he may monitor the buyer’s payments and be sure they are being made on time.

While a lender does technically have the right to demand full payment upon knowledge that the home has been sold, they usually do not.  For the most part, lenders simply want to have payments made on time and care very little who is making them.  This is completely lender specific, however, and should not be taken as assurance that a lender will not exercise their right to demand payment.

Conclusion

Loan assumption and subject-to loans are similar in many ways but differ in their liability to each party.  There are benefits and risks to both and knowing which is right for you will depend on your particular circumstances.  For more information on both types of loans and to see if you qualify or could benefit from either type, contact a real estate investment company such as Emmaus Property Investment, LLC and speak with and expert.

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