Does "subject To" Financing Work With a Foreclosure?

By: Dave Dinkel

"Subject to" financing is where a homeowner sells his home but leaves the existing financing in place and allows the new owner to continue making the monthly payments. The deed is always transferred at this time to another owner who will be making the payments. Early in the 1980's, lending institutions got legislation passed that stopped loans from being fully assumable by new buyers because the lenders could charge additional closing fees.

The transfer of ownership violates the loan's "Due on Sale Clause" (DOSC), and immediately allows the lender to accelerate the loan and initiate a foreclosure proceeding. But, if the homeowner is already in foreclosure, it may appear to be a solution to his problem. The DOSC is what is known as a "contractual right" and is not a law, consequently there is no "Due on Sale Jail". Because of this limited penalty for violation of the DOSC (acceleration of the loan), and the fact that a check going through the lender's collection area is not checked against who owns the property and who wrote the check, few if any accelerations happen.

Certain states have enacted "anti-investor" regulations to protect homeowners from investor abuses. Some of these regulations are aimed squarely at "subject to" financing and lease options. Using "subject to" financing, the homeowner deeds over his home to an investor who is supposed to begin making the monthly mortgage payments and pay the home's associated expenses. The investor may have bought the property to flip it, rehab it and sell it, or rent it. But if something goes wrong, the investor may stop making the mortgage payment, not pay taxes or insurance and it may go back into foreclosure. Even worse, if the investor rents the property and collects the rent but doesn't pay the mortgage, the former homeowner is still responsible for the mortgage. Worst of all is when the investor pays the mortgage payments but pays everyone late by a few days. The result is a continuing credit score deduction for the former homeowner and the inability to finance a new home because he already shows having another mortgage.

The former homeowner could call the lender and tell them that he sold his home and a new owner is responsible for the property. The investor is responsible for the property, but the original homeowner is still responsible for the mortgage! If the lender accelerates the loan, the investor will stop paying the mortgage, collect the rent, and just abandon the property after he can no longer collect rent. The tenant loses their security deposit and last month's rent plus gets evicted, the former homeowner has a foreclosure and additional late payments on his credit report, the lender has a foreclosure to deal with, but the investor walks away with money in his pocket.

"Subject to" financing can work, but there are substantial risks to the homeowner, any tenants and the lender. So be wary of an offer to use this form of financing and check any documents with your attorney.

Foreclosures
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