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Creative Finance: Seller Mortgages, Subject-To, Wrap-Around Mortgages & Assignments

I can’t stress enough how important it is that Realtors critically think through these deals.  As the marginal actors become more convincing, and we become more and more bombarded by media that sounds convincing, if Realtors are going to consider these options, they are going to have to understand the aged and proven principles behind these deals.   

I’ve recently received an increasing volume of realtors, buyers, and sellers, asking about these deals, received a dramatic increase in the number of social media videos sent my way on this topic, and invitations to “investor seminars” preaching this philosophy.  

What is “creative finance”, “sub-to” and does it work? 

That answer is qualified… yes it can.

BUT you have to understand the mechanics, or everyone in the deal (including realtors) can have exposure.

There are 4 general categories of “creative finance”:

  1. Seller money mortgage Title transfers to Buyer, seller lends money for the purchase in the form of a note/mortgage
  2. Sub to, subject to, or also called buyer/sell subject to an existing mortgage Title transfers to the buyer, sellers note/Mortgage stays on the title, and buyer pays sellers note/mortgage.
  3. A wrap-around mortgage is just like a “sub to”, but the seller has a second position note/mortgage on the buyer’s property. The buyer makes mortgage payments to the seller, and the seller pays the seller’s note/mortgage.
  4. The assignment of a mortgage title transfers to the buyer, and the seller’s mortgage is transferred to the buyer, and held in the buyer’s name. The seller’s name comes off the note/mortgage.

Seller Money Mortgage:

Also called; seller financing, purchase money mortgage, and seller money mortgage.

Several realtors have called recently about structuring seller money mortgages.  When a seller has a property with no mortgage, a seller’s mortgage can make a lot of sense for several reasons.   A seller’s mortgage is also another tool the savvy agent uses to get a deal done when problems arise, or they throw it on the table when they want to impress the seller at a listing appointment.  

  • A Title Advance will tell you if a seller mortgage is an option early on.

Think of a seller mortgage like any other mortgage.  On the day of closing, the title transfers to the buyer, the buyer signs a note and mortgage, the mortgage is recorded, and a lender gives money to the buyer to give to the seller.  

In a seller mortgage however, instead of a commercial lender giving the money to the buyer to give to the seller, the seller gives the money to the buyer and the seller simply walks out of the closing room with 2 things:

  1. Less cash in hand at closing 
  2. A note from the buyer to pay the seller that cash over time

Why would a seller do this?

  • Don’t need the cash today
  • Receive more money than they would have in an outright sale
  • Delay the payment of capital gains over time (time value of money) 
  • Can make a deal happen where the buyer can’t qualify for a 3rd party loan.

Seller finance only works if the seller has no current, or only a small, mortgage.  

  • A seller with a small or no mortgage has equity they can leave in the deal and lend to the buyer.  
  • A cash-flush seller without a lot of equity can even put money into a deal, make a loan to the buyer, and receive more money over time than just the sale price.   

The single biggest seller mortgage pitfall and one you always want to explain to your seller is, DON’T OVER LEND:

  • 70% LTV is typical.  
  • “V” is for value, which is not always the sale price.  
  • Use a conservative value.  
  • If the property needs work, the value is the value today.  Not the value when the work has been done.  

Typical loan terms:

  • Again, 70% of LTV
  • 8-10% (maybe even more) 
  • 1-3 years
  • Interest only
  • No prepayment penalties
  • Some realtors structure amortized deals.  They look good at closing but can become a real disaster for the unsophisticated lender when collecting payments, or paying off.  
  • Make sure the terms conform with the Dodd-Frank rules, The Dodd-Frank rules are on the FAR/ABR “Seller Financing” Addendum.

Sellers need to get 2 things from the buyer/borrower in every deal:

  • Proof of insurance, naming the seller as “mortgagee”.
  • Survey of the property naming the lender as a “certified party”.  I can’t tell you how many times I’ve seen a survey save the lender/seller’s A$$!!!

Tips on structuring a deal:

  • Use the “Seller Money Financing” Addendum in the FAR/BAR forms.  Pay close attention to Dodd-Frank rules, they are spelled out at the top of the form.  95% of the time, a seller won’t have an issue qualifying to give the loan.  
  • Use TitleAdvance.io to determine if there is a mortgage on the property.  If there is no mortgage, the seller can leave money in the deal as a loan, and make more money.  Now you have another tool to differentiate yourself as the superior agent and make a sale happen if the train comes off the tracks.  
  • Choose a competent title insurance company or agent to close.  One who can draft the note and mortgage, as well as close the sale.  The deal will go more smoothly if it’s all done in-house.
    • Title insurance companies may supply the note and mortgage forms, but that doesn’t mean they are qualified to complete them.  
    • NOTE: a title insurance company can provide a form, but it is the “unauthorized practice of law” for them to advise on them. This is not a self-serving lawyer plug, but if you use a lawyer to draft the note/mortgage, no party will be able to come back on you the agent.  
  • Remember, the borrower always pays all loan fees, including:
    • drafting the note and mortgage 
    • doc and intangible taxes 
    • recording fees 
    • Survey 
    • lender’s attorney fee (if they have one)
  • My experience is; probably not a good idea to tell the seller to include taxes and insurance in the mortgage payment.  Unless they are a sophisticated lender, this can be a nightmare.
    • Make the borrower pay these directly to the tax collector and insurance agent, and provide proof of this to the seller/lender in writing.

Realtor Exposure and Potential Liabilities:

  • The single biggest mistake I see over and over is a seller giving a loan amount that’s too big.  If the loan amount is too big, the buyer stops paying, and the seller/lender has to foreclose:
    • The seller could be paying money in excess of what they received at closing, to pay for the foreclosure.  For example, in a deal I saw a few months ago; the seller received $10k at closing and quickly spent $15k on the FC.
    • The buyer may have trashed the property, and now the seller is the high bidder and gets the trashed property back.
  • Have the same firm drafting the note and mortgage as closing the sale.  
  • Have a lawyer draft the mortgage, note, and advise the parties on loan terms.  

Tax Advantages:

  • An often overlooked benefit (myself included) of a seller money mortgage is the tax benefit.  
  • In a dramatically oversimplified example, 15 years ago seller bought a property for $300k, and sold it this year for $1,000,000, resulting in a $700,000 capital gain.  Unless some other form of income tax protection is used, that gain is fully taxed this year.  With a seller mortgage, the tax on the gain is paid over time with the loan payments.  This provides a great way to help your seller avoid big tax burdens all at once.  
  • For an older seller, not needing a lump of cash at closing, this can be a huge benefit.  

Parting Seller Mortgage Thoughts:

  • There is a lot here.  However, seller mortgages are not as complicated as they appear.
  • Seller mortgages can be a great tool to unstick a deal frozen for financing.  
  • They can also be a great bridge to longer-term financing and make that deal close on time.  Postponing closing and allowing early possession can have huge pitfalls, including never closing (i’ve seen it many times).   
  • Remind your seller to check that the taxes are paid.  A tax lien is one of the only tools that can wipe a mortgage off the property.
  • Make sure the insurance is kept current.  We had a seller mortgaged property burn to the ground many years after the sale, the buyer’s insurance was not current, and the buyer filed for bankruptcy.  
  • Should the seller sign a personal guarantee?   The best answer is maybe.  The most practical answer is no, and always make sure there is plenty of equity (70% LTV).  
  • Tell your client about the seller financing option, tell them about industry standards, don’t give them definitive terms, and refer them to an attorney.  
  • You can text me 24-7 to help structure a deal 561-307-0885

Selling “Subject To”

Also called; “subject to a mortgage”, or in popular real estate media, “sub-to”.

The basic mechanics; 

  1. At closing title transfers to the buyer
  2. The seller is paid, usually very little or zero money
    1. Sometimes the seller even pays to close, like to a Realtor or 3rd party like a lienor (contractor, etc).  
  3. Here’s the “sub-to” twist, the seller’s mortgage is NOT paid off, survives closing, and stays on the title
  4. The buyer then makes monthly payments to the seller’s lender, hopefully… I’ll explain more.

Why buyers and sellers would consider doing a Subject To sale:

  • Can make a deal happen when
    • The seller is motivated
    • Buyer can’t qualify for a loan, or 
    • The deal is skinny on equity, and there is no money to pay for closing costs
  • Can be quicker relief for a desperate seller.
    • Caution, whenever one party is desperate your “spidey senses” should tingle.  Proceed cautiously.  Make sure everyone understands the risks.  
  • Can be “No money down” (or little money down) instant equity for a buyer.
  • Can make a deal happen where the buyer can’t qualify for a 3rd party loan.
  • Can cut down on buyer loan costs.
  • Non-qualifying buyers can qualify for a sub-to deal.  
  • Since these deals tend to have less equity and buyers don’t have much at stake, some deals close without title companies, and so they may close quicker and cheaper.
    • Caution, whenever deals close cheaper and quicker your “spidey senses” should tingle.  Proceed cautiously.  Make sure everyone understands the risks.

Seller downsides of a subject-to sale:

  • This list can go on for a long time, but the single biggest reason for a SELLER to not sell a property subject to a mortgage; sellers should never give up title to a property, if the seller’s name is on a loan, and the property is security for that loan.  
  • If you transfer the title to a buyer, you have now given up the ability to sell, rent, or give the property back to the bank to pay off or reduce the loan.  So if the loan should go into default… which loan is now being paid by a 3rd party, you have no ability to reduce the loan balance by selling the property or giving it back to the bank (also called a “deed-in-lieu”).
    • See the example below.
  • The “due on sale clause”.  This is a clause in almost all mortgages, that says if a borrower (here a seller) transfers title to the property, the seller agrees to payoff the mortgage at that time
  • Difficult, if not impossible, to obtain a hazard policy that insures the lender’s position, leaving the seller exposed in the event of loss.
    • So if the buyer gets insurance, and there is a loss, the buyer could get paid the claim the money, not pay the loan, and take off leaving the seller liable on the full loan amount.

Buyer pros and cons of a subject to purchase:

Pro’s

  • Single biggest, no personal liability on the loan 
    • A buyer can stop paying, and the worst thing that can happen is that the bank forecloses, takes the home, and the buyer gets nothing.  
    • See the example below.
  • Basically same list as a seller-financed purchase
  • Little or no loan costs, happen fast, and no qualifying 

Con’s

  • “Due On Sale” clause; the bank calls the loan, the buyer lacks the ability to pay off the loan to keep the title in their name, the bank forecloses, the buyer loses their investment.
    • The buyer can’t even claim the surplus if the property sells over the judgment amount.  

Actual client example of how a subject-to deal can go wrong for the seller.  

Facts of an actual case:

  • The homeowner closed on a $500,0000 home and got a $450,000 mortgage.
  • A few years later homeowner got an out-of-state job and had to sell, home values fell, and no offers came in that would allow a sale without the seller having to “pay to close”.  
  • The homeowner was approached by an investor that closed the sale, and the homeowner left the state and took the new job.
  • Terms of sale:
    • The title transferred to the buyer for no money to the seller
    • The buyer paid the seller’s realtor a few thousand
    • The title was “subject to” the existing mortgage, the seller’s mortgage was not satisfied in the sale
    • The seller’s mortgage had a $445k value at the time of sale.  
    • The buyer had the seller sign some forms provided by the buyer’s “investor coach”.
    • Buyer was to make all future payments to seller’s mortgage company directly.   

What happened after closing (we saw transactions like this over and over in 2010 to 2014):

  • Buyer rented the pristine property for $3500/month, collected rents for 3 years, and pocketed $125k.  
  • Buyer made a few mortgage payments and stopped, did not pay taxes, did no maintenance, property became seriously degraded, rents fell, eventually buyer stopped renting property, and fell off the map.  

At that time the homeowner came to us looking for a solution, the facts:

  • Property was now worth maybe $300k.
  • The mortgage amount was well over $500k for missed payments, forced place insurance, and taxes paid by the lender.  
  • The buyer had no assets we could identify, could not be located, and no liability to the lender. 

Seller/Lender options:

  • Get the title back, give a deed in lieu of foreclosure, and mitigate the loan balance due the lender. For this, the homeowner would have to sue the buyer and a judge order title to go back to the seller, and the cost of the suit would be about $7,500, take 6 months at a minimum, and the loan balance would be that much bigger.  

Or 

  • File bankruptcy to avoid the personal obligation on the debt.  
  • The problem here was, the homeowner was not eligible for bankruptcy, now making decent money and an easy target for a “deficiency judgment”.  

The actual solution:

  • We negotiated the homeowner’s consent to the foreclosure judgment, made it easy for the bank to retake the property, and the bank gave the homeowner a huge break, but still required a one-time payment of several thousand dollars.  Note: This was a great outcome, but can’t be predictably relied on.  The seller/borrower had $200k in exposure to the lender, they were satisfied with a few thousand dollars.  

I saw other transactions like this one where the buyer had a huge loss on the property, they dummied up the hazard insurance, and then the insurer refused to pay leaving the original homeowner with the debt amount and no property with any value for the lender to foreclose and mitigate the loan balance.   

I saw others where the lender called the loan, the “due on sale clause” was triggered, buyer could not refi, and the lender foreclosed, damaging the original homeowner, sometimes many years after the sale.  

From what I can determine there are 3 tools social media would tell you are available to sellers today, to make sellers secure with a subject to sale?

  1. Due on sale clause insurance
  2.  A “performance deed”
  3. Loan servicing company 

Due on sale clause insurance:

  • From my research, the theory is; if the lender calls the loan, the “due on sale insurer” pays the lender off, the seller’s loan is satisfied, and the buyer makes a mortgage payment to the due on sale insurer (they become the new mortgage holder).  
  • At closing the buyer or seller pays the “due on sale clause insurer” a premium for the seller’s protection.
  • The seller’s protection is only as good as the liquidity of the insurer.
  • I can find no due-on-sale clause insurers with a high rating.  They may exist, but I have not found them.  
  • I’d be reluctant to rely on any insurer for coverage that could span 30 years on a one-time payment, and if ongoing payments are required, that carries its own risks and duties.  

A “performance deed”

  • Although I have not seen one, I’ve heard them explained on several podcasts, and we’ve litigated similar cases.  The theory is; it’s a deed that has a self-executing trigger, so that if the buyer stops paying the seller’s mortgage, the title reverts automatically back to the seller.  
  • I’d love to see this in operation and execute harmoniously, but I could write an encyclopedia on the many reasons why this could not occur should the buyer exert the smallest resistance.   
  • Let’s just say (although i would never represent such a buyer), if a buyer came to me in this scenario, for 1 month’s rent, i could make sure that deed did not go back to the seller for a long time.  
  • In summary, it sounds great but is way more complex in execution.

Servicing Company

  •  Is paid by the buyer/borrower, and if the buyer is not paying their mortgage, how does this help?  


Realtor exposure and potential liabilities:

  • A Realtor’s best bet to avoid liability to a buyer or seller in a “subject to” sale, refer your client to a competent real estate attorney for an opinion. 
  • Some attorney’s like to justify their existence by making things more complicated than they have to be.  
  •  Some are practicing out of their zone.
  • A good attorney can break down a deal, explain it to anyone, get all to understand the opportunities and exposures, and let the buyer and seller make an informed opinion.   

Only if a lender has no personal recourse to the seller in a “subject to” sale, then a subject to sale may make a lot of sense.  

  • Problem is, almost all residential loans require the borrower to have personal liability. 
  • Some commercial loans have no personal liability.  

Wrap Around Mortgage

Now comes the “wrap-around mortgage” also called a “Wrap”.  

If you understood “subject to”, a wrap is an easy next step.  A wrap is a subject to sale, where the buyer pays the mortgage amount to the seller, the seller pays the seller’s mortgage lender directly, and the seller holds a 2nd mortgage on the property.

  • Now the seller has a direct and proven line of recourse against the property if the buyer does not pay.
  • The seller is in the know as soon as the buyer stops paying.  
  • The seller can collect more from the buyer than the value of the mortgage payment, and keep the difference each month.  
  • Makes insuring the lender’s position easier, because now the seller is a named mortgagee.  

Wrap Problems?

  • What if the seller stops paying the mortgage?  Buyer has to continually check up on the mortgage status, and if in default, reinstate and make payments directly.
    • Can be tough to do, because the buyer is not an authorized party on the loan.  
  • The seller still has to sue for remedy, but the buyer has few real defenses.
  • A wrap violates the due-on-sale clause, which can still hurt the buyer’s position.

Summary

If a “subject to” make sense, a wrap provides security to the seller, and in many cases, I would recommend these to my clients, even if they have personal liability on the loan.  

Assignment of Mortgage

Basic mechanics; title closes, transfers to the buyer, and seller’s loan stays in place.  

  • Like a sub-to or wrap, the seller’s mortgage stays in place, is not paid off, and survives closing.  
  • Unlike a sub-to or wrap, the note and mortgage are now in the buyer’s name, and the lender has zero recourse against the seller.  
  • The buyer gets the benefit of all the loan payments the seller made over the loan life.  Shorter term, increased equity.  
  • The seller has zero liability or exposure after the sale.

The big problem with assignments: 

  • Almost no residential lenders do them anymore (they died about 20 years ago).
  • In many commercial deals realtors may say they are possible, but few commercial lenders will facilitate them unless there is little or no equity.

Disclaimer

All references to a contract are the FL FAR/BAR AS-IS 2021, and most recent riders

The foregoing is a summary of the opinions of attorney James Brown, provided to licensed Florida realtors, and SHOULD NOT be relied on as legal advice, tax advice or a complete explanation of any particular issue. Every situation is different, and you should seek qualified legal advice before making a decision.

Published May 2, 2023

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