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Navigating Due On Sale Clauses For Subject-To Deals

How can real estate investors get a better handle on navigating due on sale clauses for more profit, and with less risk?

‘Subject-to’ real estate investment deals have been a staple in real estate books and educational courses for a couple of decades. Yet, the factors surrounding them have changed dramatically and are still in flux. They can appeal to many investors, and be incorporated into multiple strategies. However, some investors have recently been questioning how due on sale clauses are being treated today, and what their liability is when participating in these types of deals.

Subject to deals have the potential to be incredibly profitable. Yet, with investors becoming more defensive and banks seemingly acting with absolute immunity, investors are smart to consider how due on sale clauses could potentially impact them in terms of liability and functionality. This applies whether they are flipping, buying and holding or simply selling these deals.

For those not familiar with all of these terms, let’s break them down briefly for clarity:

What is Subject-To?

‘Subject-to’ refers to buying a property that is subject to any existing debt or mortgage liens. The idea is that this debt won’t need to be immediately paid off, making transfer easier, especially in tough mortgage markets.

What are ‘Wrap-Around’ Mortgages?

Wrap around mortgages, or ‘wraps,’ are used to encapsulate multiple mortgages in a subject-to deal. They can also be used when a property is being sold for more than the current mortgage balance and a seller is willing to hold the note.

How Does a ‘Due On Sale Clause’ Work?

One potential issue with the above deal structure is the due on sale clause. This is a clause commonly found in mortgage paperwork. Essentially, it gives the lender the right to call the entire outstanding loan balance due immediately upon the sale of the property held. Think of it as a form of collateral.

The big question for real estate investors is whether or not a lender will actually exercise this right, and if they do what liability does that dump on them?

How Likely are Banks to Follow Through Today?

Subject-to real estate deals obviously wouldn’t have ever become popular, or have been profitable if lenders religiously pursued their right to collect. In recent years of distress and the foreclosure crisis, the last thing most lenders wanted was more dead weight. Provided the loan was being paid, they probably didn’t care who was paying it.

At the height of the last housing boom, when equity was rocketing fast, they may have frequently looked for reasons to call balances due to cash in. Looking ahead as we move into a new boom phase, this is a trend that could rear its head again.

What Happens if Due On Sale Clauses are Executed?

When lenders pursue this clause, investors or new owners will generally have a grace period to try and sell on or refinance the property and extinguish the debt. In some cases, loans can also be assumed.

There are various protections for all sides of the transaction from holding deeds in escrow, to clauses permitting foreclosure, etc. Nevertheless, it could get ugly.

As an investor, it is critical to watch out for all liabilities resulting from due on sale clauses. This applies whether you are just playing the middleman and are flipping houses, are holding this property long term as a residence or rental property, or are simply assigning contracts. The main key is disclosure. Always disclose everything and no one can point fingers at you for anything. Finally, remember that while there are many short cuts, none that can jeopardize your reputation should be taken.

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