When it comes to creative real estate strategies, subject-to deals often stand out as a great option for investors. A subject-to transaction allows buyers to take ownership of a property while keeping the existing mortgage in the seller’s name. It’s an effective way to acquire real estate without getting a new loan. However, one key element of these deals is the due on sale clause. This article will break down how subject-to deals work, what the due on sale clause really means, and how to approach these deals responsibly.
What Is a Subject-To Real Estate Deal?
A subject-to deal allows you to purchase a property by “taking over” its existing financing. Here’s how it works:
- The seller transfers the deed (ownership) of the property to the buyer.
- The mortgage on the property remains in the seller’s name.
- The buyer agrees to take on the payments of the existing mortgage.
For example, imagine a homeowner named Ryan is facing foreclosure and wants to sell his home quickly. You, as an investor, agree to buy the house subject-to the existing mortgage. The property deed transfers to you, but Ryan’s mortgage with the bank (e.g., Bank of America) stays in place, and you commit to paying off that mortgage monthly.
This strategy lets you acquire properties with minimal upfront costs and no need to qualify for a loan. It’s particularly useful when a homeowner is motivated to sell quickly, such as in foreclosure situations.
The Role of the Due on Sale Clause
The due on sale clause is a section in most mortgage agreements. It states that if the property is sold or ownership is transferred, the lender has the option to demand the remaining loan balance be paid in full. This clause exists to protect lenders from losing control over the loan terms.
Where can you find it? Typically, the due on sale clause is buried deep within the deed of trust or mortgage agreement. It may be in fine print, but it’s almost always there.
Let’s be clear: the due on sale clause doesn’t prohibit you from selling the property. Instead, it gives the bank an option—not a legal obligation—to call the loan due.
Why Subject-To Deals are Legal
A common misconception is that subject-to deals violate the due on sale clause. This isn’t true. Doing a subject-to-deal triggers the clause, but triggering is not the same as breaking the law. Banks are not obligated to call the loan due when the clause is triggered. Historically, they rarely enforce it, as long as payments are made on time.
The key is ensuring proper disclosures to both the buyer and seller involved. Each party should fully understand the risks and what the due on sale clause means for them.
Why Banks Rarely Enforce the Due on Sale Clause
You might wonder, “Wouldn’t banks call every loan due if they could?” The truth is, they’re in the business of making money—not owning real estate. As long as mortgage payments are made consistently, most lenders have no incentive to demand full repayment.
In over 35 years of experience and 15,000+ subject-to transactions, fewer than 10 cases of enforced due on sale clauses have been reported. Why? Because banks prioritize receiving payments. If they wanted to own property, they’d be real estate companies—not banks.
That said, there are some rare instances where the due on sale clause has been enforced. Examples include when a bank is acquired by another lender looking to clean up its books or when a disgruntled seller reports the sale. These cases are exceptions, not the rule.
How to Minimize the Risk of a Due on Sale Clause Being Called
While the clause is rarely enforced, there are steps you can take to minimize the chances of it happening:
- Pay the Mortgage on Time: Banks care more about receiving payments than enforcing the clause.
- Handle Insurance Correctly: Ensure your insurance setup is accurate and includes the appropriate names and roles. (More on this below.)
- Stay Under the Radar: Avoid activities that might draw unnecessary attention, such as openly advertising the purchase as a subject-to deal.
- Maintain Communication with the Bank: If something changes, address it proactively.
Getting Insurance Right in Subject-To Deals
Improper insurance arrangements are one of the fastest ways to trigger a due on sale clause. It’s essential to have the correct parties listed on the insurance policy. Here’s how it should be structured:
- Named Insured: The current property owner (you or your LLC, if applicable).
- Additional Insured: The original property seller.
- Primary Mortgagee: The lender (e.g., Bank of America).
If you’ve sold the property to an end buyer with an owner-financed wrap, the structure changes slightly:
- Named Insured: The end buyer.
- Additional Insured: The original seller.
- Primary Mortgagee: The lender.
- Secondary Mortgagee: Your LLC or company.
Work with an experienced insurance agent familiar with creative finance deals to ensure the setup is correct. Not all agents or underwriters have experience handling wraps and subject-to deals.
What Happens if the Due on Sale Clause is Enforced?
If a bank calls the due on sale clause, you still have options. Here are strategies to handle it:
- Pay Off the Loan: Use savings or private capital to pay the loan balance.
- Refinance: Secure a new loan to cover the outstanding mortgage.
- Transfer Ownership Temporarily: Return the property deed to the seller temporarily, or place it in a trust to appease the lender.
- Negotiate: Some banks may accept continued payments rather than foreclosing, especially if you’re upfront about difficulties.
Although enforcement is rare, having contingency plans in place is smart. Building a rainy-day fund from down payments or profits can help cover unexpected costs.
The Ethics and Responsibility of Subject-To Deals
While subject-to deals can be lucrative, they come with ethical responsibilities. Sellers are trusting you to make payments on the loan tied to their name. If you fail to uphold your end, their credit suffers—not yours. Similarly, buyers need clear disclosures and contracts outlining the risks involved.
Always do what’s right, even if it’s not in your best financial interest. Whether that means paying out of pocket to resolve an issue or making extra efforts to protect a seller’s credit, your integrity is what builds long-term success in real estate.
Tips for Working with Subject-To Deals
Here are a few best practices for subject-to investors:
- Use Solid Contracts: Work with an experienced attorney to craft contracts that protect all parties.
- Disclose Clearly: Explain risks, benefits, and processes to both sellers and buyers in plain language.
- Learn the Details: Study due on sale rules, insurance practices, and wrap techniques to avoid costly mistakes.
- Partner with Experts: Build relationships with attorneys, CPAs, and insurance agents who understand creative financing.
Final Thoughts
Subject-to deals are powerful tools for real estate investors, but they require careful execution. By understanding the due on sale clause and taking the right precautions, you can minimize risks and protect everyone involved. Focus on clear communication, ethical practices, and proper planning to turn subject-to deals into a win-win for all parties.
