When it comes to real estate investing, especially using creative strategies like owner financing, ensuring your deals are properly insured is critical. Poorly structured insurance policies can trigger financial headaches, pointless lawsuits, or the dreaded due-on-sale clause. In this guide, we’ll lay out exactly how to handle insurance for owner-financed deals, including subject-to purchases and wraparound mortgages.
Why Insurance Matters in Owner-Financed Deals
Insurance isn’t just another checkbox in real estate investing. It’s a safeguard against unexpected disasters and claims that could cripple your deal. Done incorrectly, however, it could raise red flags with banks or leave you, your seller, or your buyer unprotected.
For creative financing methods like subject-to-deals and wraps, structuring your insurance the right way keeps everything smooth—avoiding unnecessary risks while giving all parties the coverage they need.
What Is an Owner-Financed Deal?
Owner financing is a broad category of strategies where the property seller provides financing rather than the buyer using a traditional mortgage. Two popular types of owner-financed deals include:
Subject-To Deals
A subject-to deal occurs when you take over the seller’s mortgage payments without officially transferring the loan into your name. The seller’s mortgage remains active, but you, as the buyer, control the property.
Wraparound Mortgages
In a wrap deal, you purchase the property subject to the seller’s mortgage, but then resell it to another buyer by creating a new loan. The new buyer’s loan typically has a higher balance or interest rate, allowing you to profit from the difference.
The Insurance Challenge
Creative financing methods have unique insurance requirements. Structuring policies incorrectly can trigger unnecessary scrutiny from the seller’s lender, particularly via a due-on-sale clause.
What Is a Due-On-Sale Clause?
A due-on-sale clause allows a lender to demand full payment of the mortgage if ownership of the property transfers. Most banks won’t call the loan due if payments are made on time, but improper insurance changes (like removing the seller’s name) could force their hand.
This is why keeping names and structures on insurance policies consistent is essential.
Structuring Your Insurance Correctly
The key to insuring an owner-financed property is ensuring the right parties are named in the correct roles on the policy.
Subject-To Deals
When buying a property subject-to, follow this structure:
- Named Insured: Your company (as the buyer).
- Additional Insured or Also Insured: The seller (their name must remain on the policy).
- Primary Mortgagee: The bank or lender holding the mortgage (e.g., Chase, Wells Fargo).
Wraparound Mortgages
For a wraparound deal, the structure changes slightly to include the new buyer:
- Named Insured: The buyer purchasing from you.
- Additional Insured or Also Insured: The original seller.
- Primary Mortgagee: The lender for the original loan.
- Secondary Mortgagee: Your company, acting as the financier for the wrap buyer.
This setup ensures all parties involved—banks, sellers, and buyers—have their interests covered.
What About Rentals?
If you’re holding the property as a rental, the structure simplifies:
- Named Insured: Your company.
- Additional Insured: The seller.
- Primary Mortgagee: The original lender.
Actual Cash Value vs. Replacement Cost
One of the biggest mistakes investors make is not understanding the type of policy being used. Insurance policies fall into two main categories:
- Actual Cash Value (ACV): Covers the depreciated value of damaged or lost items. For example, if a 10-year roof costing $10,000 is halfway through its life, you’d receive $5,000 minus your deductible.
- Replacement Cost Value (RCV): Covers the full cost of replacing the item, regardless of depreciation. Using the example above, you’d receive the full $10,000 (less the deductible).
Always require an RCV policy on your deals. ACV policies may be cheaper upfront, but they leave both you and your buyer at serious risk of uncovered expenses.
Finding the Right Insurance Agent
Not all insurance agents understand investor needs, especially when it comes to creative financing. Work with agents who specialize in or are familiar with subject-to and wraparound transactions.
To vet potential agents, ask direct questions:
- “Have you structured a subject-to or wraparound policy before?”
- “Can your underwriters handle complex mortgage arrangements?”
Avoid agents who seem unsure or confused. You need someone experienced enough to ensure your policy is rock solid.
Mitigating Risk: Power of Attorney
Whenever you purchase a property subject to the existing mortgage, always obtain a power of attorney (POA) from the seller. This document allows you to perform specific actions related to the property on the seller’s behalf, such as resolving claims or signing loss-draft checks.
Without a POA, you could face major delays or even gridlocks if the seller becomes unavailable or uncooperative. Properly structuring the POA to limit its scope to the property in question makes sellers more comfortable signing it.
Common Insurance Pitfalls to Avoid
- Skipping the Seller’s Name
Always keep the seller’s name on the policy as “also insured.” Removing it could alert the bank unnecessarily.
- Using the Wrong Policy Type
Choosing ACV over RCV might save a few bucks, but it adds significant risk in the event of a claim.
- Working with Inexperienced Agents
Stick with agents who understand the nuances of subject-to and wrap-around deals. Missteps here can cost you big.
- Not Choosing Adequate Coverage
Always ensure the policy covers, at minimum, the current loan balance.
The Role of Claims and Loss Drafts
When loss occurs (e.g., a house fire), the insurance payout check often includes multiple names: the buyer, seller, mortgagees, and sometimes you. Having a clear structure—backed by a POA—streamlines the process of cashing the check, ensuring repairs are handled effectively.
Issues crop up most often when checks require signatures from all involved parties. Without a POA, you could struggle to finalize claims quickly.
Final Thoughts
Insuring owner-financed deals doesn’t have to be daunting, but it does require attention to detail. A well-structured insurance policy protects every party involved and minimizes the risk of disruptions to your investment strategy.
Whether you’re working on a subject-to rental or a wraparound mortgage, the principles remain the same: include everyone who needs to be covered, require robust policies (RCV is best), and build relationships with knowledgeable agents who can guide you.
Don’t skimp on these steps. The effort you spend now saves you countless headaches later.
Ready to dive deeper into creative financing strategies? Tools, training, and resources from platforms like Propelio and Creative Cash Flow can help take your investing to the next level.
