Epic Real Estate Investing - EPREI 028 : How to Invest 'Subject To' and Overcome the "Due on Sale" Clause

Episode Date: February 26, 2012

Taking ownership of a property subject to the existing financing excites the hell out of most investors, however... the fear of the dreaded "due on sale" clause stops them dead in their tracks. There's nothing to fear but fear itself, and on this episode Matt explains why. Get your free real estate investing course at http://FreeRealEstateInvestingCourse.com Learn more about your ad choices. Visit megaphone.fm/adchoices

Epic Real Estate Investing podcast, episode 28. Without further delay. Your guru. Sorry. Your guide to a better life through real estate investing. Matt Terrio. Hello and greetings from the Epic Real Estate Investing podcast, the podcast that will show you how to build wealth through creative real estate investing.

So you'll have the option to realistically retire in the next 10 years. or less and enjoy the good life while you're still young enough to do so. My name is Matt Terrio, author, full-time real estate investor, and family man. If this is your first time listening to this show, you're going to want to do two things. First, go back and listen to episode one for the ground rules of the show. And two, download the free real estate investing course, how to do deals, no money required. And you can get that for free at free real estate investing course.com. It's a step-by-step course of where I unveil the mystery around doing deals.

with no money or credit. Okay, so since opening up the Epic Pro Academy, the majority of the questions I've received via email or our weekly coaching calls have been around subject to investing and specifically how to overcome or how to beat the due-on-sale clause. And I guess it shouldn't surprise me as, you know, when I first heard of the subject to strategy, my initial thought was like, oh my God, I'm going to take over the world.

This is so cool. You mean I could just go out there and pick up, a house with no money and I don't even have to get a loan either. I mean, that was the coolest concept I'd ever heard. And then shortly after processing that thought, I was like, wow, what seller in their right mind would do a thing like that? I mean, that sounds like a smoking deal for me, the buyer, but the seller sure seems to be getting the short end of the stick on that one. And if you're not familiar with what subject to is, I mean, it can be as simple as finding a motivated seller and having them sign the deed over to you while they leave the existing

loan in place and all you have to do is just merely make the payments on the loan. I mean, on the street, this is called a subject to transaction. The buyer is taking ownership of the property subject to the existing financing. That's how it works. So you, the buyer, now owns the property and the seller still owns the liability of the loan. They're still responsible for that loan. Again, smoke and deal for the buyer, but what seller in their right mind would do a thing like that?

At least that's what I was thinking. Well, the key words here are motivated. seller. I mean, remember our mantra. The center of every real deal is the seller's motivation to sell. I mean, if you don't have a motivated seller, I mean, you probably don't have a deal. I mean, a real deal is, as we define it as real estate investors. Subject two, it's a really simple strategy, too. I mean, one of which is very doable, but, you know, like every strategy, it's not going to be a good fit for every situation. Like seller financing or lease options or private money or hard money, whatever may be. Subject two, it's just a number of

another tool in the toolbox of which enables you to use someone else's money to transact your real estate. I mean, typically your ideal situations for subject two are, you know, when you cross pass with property owners behind on their payments, experiencing pre-foreclosure or owners that have little to no equity in their property. I mean, they'd be the most open to a subject transaction probably. As well, though, just about any situation where timing is of the essence, I mean, any situation where a quick takeover of the property is in order to solve the challenge at hand. I mean, that's also an ideal scenario for a subject to transaction. So, should you come across a scenario where a subject to transaction, it seems applicable,

in order for you to have a chance of making it work, you've got to really focus on what's in it for the seller. I mean, it's always what's in it for the seller, right? And that actually goes for every deal, I suppose. But if you want to get what you want, a property subject to the existing financing, then you've got to got to give the seller what they want. And in most cases, in a subject two, the seller's going to really want peace of mind. There's something going on in their life that's keeping them up at night. So you're going to be giving them a good night's sleep. That's what your subject to transaction is going to do. And most of all, you'll be preserving their credit score as much

as possible, I suppose. It depends on how much it's been damaged before you found them. But that's primarily the two benefits. You give them peace of mind and you get to preserve their credit score. That's exactly what a subject to transaction enables you to give them. Now, if they're concerned about whether you are going to follow through or not, I mean, actually make those payments, I mean, which is a very common concern that will come up, that typically does come up somewhere in the conversation. You can simply explain that the risk of losing the equity in the property, the time that you have invested, the money that you have invested, and the equity that you're getting, the risk of losing all that will keep you from missing payments. I mean, as an investor,

it's your best interest to maintain those payments. This is how you feed your family. And you'll explain it to the seller in some fashion like that. Now, subject two, as I mentioned, it's not going to fit every scenario. But when it does, it's not as hard to execute as it may seem as, as long as you're clear with regard to what subject to is. I mean, if you know what it is and you know how to explain it to the seller and you know what steps to take to protect you in the seller, you can build your entire business around using this strategy. I don't see anything wrong with that and I don't think that's unrealistic by any means. In that comment, I mentioned as long as you know what steps to take to protect you and the seller. From the buyer's perspective, as good as the strategy sounds,

there are some things to be aware of, some things that you need to protect yourself from. And one of the ways to protect yourself is to make sure that the seller knows everything. that you know about this strategy. I mean, it's in your best interest to essentially educate the seller on what exactly it is that you'd be doing by taking over their property subject to. Full disclosure and complete transparency with the seller is going to keep you out of a lot of potential trouble, as it typically always will. But with subject to, full disclosure is not a step that you want to accidentally miss or forget.

And basically, you just don't want to find yourself in court with the seller accusing you of stealing their home. That's not a good place to be. I mean, the investor almost never wins that argument. And now, unless you've covered every base. And even then, I mean, there could be some risk. So full disclosure, best policy. And my motto is just be straight with people and make sure everyone gets what they were promised.

And that right there should keep you out of court. A very cherished real estate investing mentor of mine said, you want to stay out of court, make sure everybody gets paid. That was his motto. And I've kind of adhered to that. And I haven't found myself in court yet. Knock on wood. Okay.

So there are also, there are two more places where you want to be very careful. The next is, don't take over a property just because the owner agreed to give it to you. I mean, it can be very exciting, especially if it's the first time for you when a seller signs over the deed to you for nothing. I mean, they just say, here, take it. My caution to you is, don't take the property just because the seller agreed to sign it over to you. I mean, it still has to be a good deal. And a good deal defined is a property that meets your criteria and a seller that will meet your terms. You need both parts of the equation to be present for it to be a good deal for you.

I mean, I understand, yes, you're excited because you found a seller that has met your terms, but you still have to confirm that it's a property that will meet your criteria, specifically that it'll meet your minimum deal standards for either your cash goals or your cash flow goals. Now, the biggie that you want to protect yourself from is, this is the big one, it's probably one of the most feared yet misunderstood, but it's also the most fascinating subjects in real estate investing. It seems to be the most fascinating. Everyone's obsessed with this for some reason. It's the dreaded due-on-sale clause. Now, as simple as a subject-to transaction can be, it's this specific clause found in most loan documents today that stops most investors dead in their

tracks from moving forward on a subject-to deal. Now, I'm going to spend the remainder of this podcast dispelling as many myths as possible about the due-on-sale clause as I can. And I'm also going to give you two strategies, simple and effective strategies on how to overcome it, on how to beat it. Now, some of the myths can be dispelled by simply just understanding the due-on-sale clause's origin, understanding its history, where it came from, why it's there. So where did it come from? Okay, glad you asked. The due-on-sale clause, and you'll sometimes hear it referred to as an acceleration clause, it's an authority clause in a loan document that gives the lender the right to call the loan due, regardless of when, regardless of the amount of the outstanding balance.

It gives them the right to call that due for really just about any reason that they want. Now, many people think the due-on-sale clause applies only when title of the property is transferred away from the borrower's name. Not true. Most due-on-sale clauses, they paint with a very broad stroke, and they're getting broader and broader. And just about any modification to title or interest in the property or possesses. possession even, can trigger the due-on-sale clause of which can include the subject property no longer being the owner's primary residence.

I mean, just by turning the primary residence into a rental property, that can trigger the due-on-sale clause. And in some due-on-sale clauses, and this is crazy, but it's true, it's worded that even if the owner contemplates a sale or transfer of title. And now I don't know how the lender would be able to prove that in court, but that's how it's worded. even if the owner contemplates a sale or transfer of title. And if the owner doesn't notify the lender in writing, the lender can accelerate the loan and call a due. Again, I don't know how they would prove that, but I've definitely seen some due-on-sale clauses with that exact verbiage.

And I'm drawing your attention to some of these examples to demonstrate that lenders can accelerate a loan in a multitude of scenarios. But do they? No, rarely. They rarely do. It's not common practice by any means. It's not in their best interest.

I mean, the bank certainly has the right to, but typically they just won't because it's rarely in their best interest to do so. So, if they rarely do it, then why is it there? Well, glad you asked. Lenders, they began including these due-on-sale clauses in their loans back in the 70s during a time where interest rates were on a dramatic rise. They were rapidly increasing. And instead of taking out new loans, I mean, just regular Tom, Dick, and Mary homebuyer were when they would go to buy a profit, They were just assuming the existing loans that were on those homes because the interest rates of those loans were so much lower than the newer loans that if they were going to go get a new loan. And lenders then, they recognized that this was a problem and they started to insert the due-on-sale clause to protect themselves from their worst competition themselves.

And they cited that they needed this clause to protect their collateral by monitoring and being aware of who was actually living in the property, of which is BS. They don't care. They just wanted to generate new loans at the higher market interest rates. And to prove that that's the case, I mean, lenders haven't been enforcing

their due-on-sale clauses since the early 80s. And why haven't they? Well, because they lose money if they wrote a new loan. The interest rates have been on a steady decline for a very long time,

and we're at all-time lows right now. They would lose money if they wrote a new loan under those new lower interest rates. So they've allowed the vast majority of subject two, to stay in place. So the due-on-sale clause really is just more of a hedge against the market for lenders than it is to protect their collateral, as they'd say, which is actually a good

argument. That actually makes sense, but they don't give a damn. I promise you, they don't give a damn about the property as much as they do about the extra percentage point or two they're getting on the loan on that property. Now, homeowners, they eventually caught on too. I mean, they started fighting back, citing that it was unfair trade practice, and many homeowners were winning those arguments. However, in 1982, the lenders ultimately won in a Supreme Court case, was the Federal Savings and Loan Association v. De La Cuesta in 1982. But what the lenders won, though, was really nothing more than just the right to enforce the due-on-sale clause, of which leads me to dispelling another myth. Violating the due-on-sale clause is not against the law. It is not illegal.

You are not going to jail for violating the clause. Did you hear that, realtors? It's not illegal. I don't care what your broker has told you. You cannot confuse criminal liability with civil liability. They're very different. It is not against the law and you're not going to jail if you violate the due-on-sale clause. Because in order for something to be illegal, there must be a violation of an actual law.

There is no federal or state law stating it's a crime when violating the due-on-sale clause contained in your loan docs. I mean, the worst thing, the worst thing that could happen is that the lender exercises their rights under the due-on-sale clause and just takes the property back. And even then, they can't do it inside of 30 days. Hint, hint for the wholesalers out there. And even after the 30 days, if the property is occupied, the lender will have to abide by normal foreclosure proceedings. Which should be enough time for most fix and flippers to execute their strategy. Hint, hint to my fix and flippers out there. So what about the long-term investors, though?

I mean, the big question is, are you willing to take over a property subject to with the risk of the lender catching on, with the risk of the lender busting you? That's really only a question that you can answer. I mean, you know your situation better than anyone else. But if the answer is yes, meaning you're willing to take the risk. And I use the word risk very loosely. But if you're willing to take that on, you have two real viable options on how to approach it. At least the two that I know of and the two, they are the same two that have worked for me. I mean, you can either go in the back door and try to see.

sneak in or you can go in the front door just screaming, hey, honey, I'm home. So let's discuss the back door first, okay? It's the old trust assignment trick. All right, there's a loophole that many investors exploit the Reagan administration back in 1982 enacted the Garne St. Germain Depository Institutions Act, of which was to revitalize the housing industry by ensuring the availability of plenty of money to loan for the purpose of home purchases, probably very similar to something that's going to happen soon. That's just my guess. And within that act, there was a significant consumer benefit that included, it allowed

anyone to place real estate in their own trust without triggering the due-on-sale clause. Now, depending on how political you want to get, and I'm not a real political person, but depending, it's not difficult to see. I mean, in my opinion, it was a loophole created for the wealthy as a wealth preservation and protection instrument. The benefit, it also allowed the transfer of property to heirs and family members freely without triggering the due-on-sale clause. I mean, basically, this change was so that the rich didn't have to play by the same rules as the common folk. Well, enter the educated real estate investor armed with the land trust.

Now, if you don't know what a land trust is, it's an agreement of which one party, the trustee, holds ownership of a piece of real estate or real property for the benefit of another party, the beneficiary. Okay? paying attention? Are you seeing an opportunity in this land trust thing yet? You see, a transfer of real estate using a land trust is exempt per the Garn St. Germain Act. Get it? Okay, I'll break it down to you in three simple steps. Everybody likes step by step. Okay, you come across your real deal, right? You've got a property that meets your criteria and you've got a seller that'll meet your terms and your terms being that you want the property subject to the existing financing. Good to go.

Everything's in place. So, step one, your motivated seller signs a land trust naming you as the trustee. The seller is the beneficiary. Follow me? Step two. Your motivated seller transfers title to you, the trustee. Thank you, Garn, St. Germain Act. As per this action, there is no violation of the due-on-sale clause.

The banks can't do anything about it. The transfer to a trust is exempt. Excited yet? I thought so. Step three. The motivated seller quietly assigns their interest in the trust to you. Quietly meaning they don't record it publicly. Very similar to transferring stock in a corporation.

So since this assignment isn't recorded, there is no public record of it. The motivated seller then moves out and goes on about their business and then you or your tenant get to move in. Tadda! See how simple that is? You are now the beneficiary of the trust, the beneficiary of the trust that owns the property. Now, the trustee, also you,

all there's left to do is make the existing loan payments and you live happily ever after, right? Well, I wish it was that simple. It's not that cut and dry. I mean, you must know that when the motivated seller assigned to you their interest in the trust, that indeed triggered the due-on-sale clause. But how will the lender ever know?

It's not recorded publicly, not public information. So how will the lender ever know? Okay. Typically, there are only three ways of which the lender will get wise to the transfer. First, a change of the name on the deed will definitely let the lender know. However, the name on the deed is a trust,

a trust of which, if you did it right, it bears the motivated seller's name. So if Joe Smith was the name of your seller, it would be the Joe Smith Trust. Okay? Or you can do it with the property address. If it's 123 Main Street, you could be the 123 Main Street Trust.

You see, by naming the trust with something related to the property, it isn't even going to raise an eyebrow as it's a very common estate planning practice. Happens all the time. It happens all the time every day in non-subject-to transactions. There's nothing out of the ordinary here

for the lender to even investigate. Second, another way the lender typically finds out is when they receive a mortgage check from a name different from what the name they're used to seeing. But that's really not likely as bank officers. They're so far removed from the payment processing in the administration department. And, you know, actually as an extra precaution, you know, there's another way to make sure that that doesn't happen. Just open up a new checking account in the name of the trust and send checks from the trust. I mean, not even the officers would investigate if they saw. the name of the trust on the check.

I mean, everything would line up. There wouldn't even be a hint of suspicion. Now, the third way the lender might get wise is the most common way. They see a change of beneficiary on the hazard insurance. You see, when you change the name of the insurance beneficiary, the lender receives a copy of the change also. But if title went into a land trust, the new beneficiary in the insurance policy is the trustee of the land trust.

and that would be you. So you've got your insurance without having to change the name of the beneficiary. Again, this is a very common estate planning practice of which the lender sees on a daily basis and has no reason to raise an eyebrow. So there, if you know what you're doing, it's very easy to overcome that due-on-sale clause. There's not much risk in the due-on-sale clause at all. However, there is still a risk. Okay?

So that's sneaking in the back door. Let's try the front door approach now, which I've done also, and this is probably the way I do it most often now. Let's imagine from the beginning, the same scenario with our motivated seller, as soon as you get an agreement from the seller allowing you to take the property

subject to the existing financing, turn the entire file over to a third-party servicing company, and let them do the rest. I mean, let them do everything. Let them communicate with the seller, let them communicate with the bank. I mean, completely remove yourself from all parts of that,

conversation. It's kind of like when when two lawyers talk. When lawyers talk to lawyers, they speak the same language. They respect each other's position. They understand what each other's going through. And they, you know, they just pass paperwork back and forth. There's no emotions involved. It's just an everyday thing. It's no big deal. And that's how it works when note servicing companies are speaking with other note servings and companies. They speak the same language. They understand how it works. And it's just passing paperwork back and forth. So once that's done, once they've completed their duties, all there is for you to do, I mean, whatever you do, just make the payments. Actually, in both scenarios, make the payments.

Do not miss a payment. I mean, you've put in all that work. You've got a smoking deal. You stand to make a great profit. And don't mess it up by missing or even being late with a payment. Don't give the bank or the lender any reason to call you. And that's one of your ultimate lines of defense. You know, because in today's marketplace, in today's real estate market,

with the amount of foreclosures, the amount of pre-foreclosures, the amount of short sales, and all the distressed homeowners and the loan modifications and all that out of the ordinary stuff of where the banks are losing money, but do you think they would even have the manpower or they would let go of the manpower to go and police their accounts that are in good standing? No way. And in my opinion, I mean, we've got another four to five years of this type of environment, depending on which source you listen to, I guess.

But I believe we've got another four to five years for the lenders and banks to process their delinquent accounts. They're not even going to have time to investigate the accounts that are being paid. All right. So maybe you're thinking, okay, this subject to thing is all fine and dandy, right? But isn't this unethical? I mean, Matt, you've said a lot of things that are like you're keeping secrets. Isn't this fraudulent? Well, let me ask you this.

If it were unethical or if it were fraudulent or immoral, whatever word you want to use, why was so many different states in their standard state, Realtor Association, purchase agreements and paperwork, why would they include subject to provisions? Why would they include subject to as a financing option on the contract? California has it, Utah has it, New York has it. I mean, those are the ones that I know for sure, but I'm pretty sure all states do. But I know they do for sure.

Further, the state bar associations have had no problem with lawyers aiding their clients and concealing these types of property transfers using the land trust example I just gave you. I mean, I'd cite the court cases for you to prove it, but you might get the impression that I'm much smarter than I am. Okay, I'll give you this example. In Alaska Bar Association Ethics Opinion 8-2-2, the committee declared circumventing a contract term under these circumstances is not fraud or fraudulent conduct. The attorney's participation would amount to no more than concealing a breach of contract. Breaching a contract is not a crime.

See, again, we've got the difference here between criminal liability and civil liability. But the Alaska Bar Association didn't even want to bother with it. That's how insignificant it was to them. The Illinois Bar is also on record concluding that the breach of the contract of sale in contravention of the due on sale clause is not a crime. And you can find the same type of record in the Virginia Bar. They had the same conclusion in Opinion 471. So if it's not illegal, unethical, or fraudulent for an attorney or a broker to sneak in the back door, it isn't for you either.

In Ethics Opinion No. 96-2, the Alaska Bar actually ruled that an attorney has no duty to disclose the existence or the implications of a due-on-sale to part to a transaction whom he was not representing. They said he didn't even have the duty to disclose it, of which, you know, I think that might be going a little too far, especially in a subject to transaction. As I mentioned in the beginning, make sure your motivated seller is educated, or at least as educated as you are now,

on the matter of transferring title subject to the existing financing. Full disclosure is always best. Yes, that attorney might have gotten away with that, and the Alaska Bar might have ruled that way, but there's no reason to take it that far. Full disclosure is always best. Either way, though, you're not going to jail. The most you've got to lose is the time you've invested in the money you put in the deal,

which brings me to best practices when investing subject to. I mean, it's an ideal strategy for short-term investing, like wholesaling and fix and flipping. I mean, kind of like a bridge loan, so to speak. If you have that situation, go for it. Just do it. I mean, if you're confident you can get in and out in under six months, make it happen. Now, if you're subject to investment is going to be a long-term hold type play, I would recommend not investing any more in the deal than you're willing to lose. I mean, if you give a motivated seller, say, $50,000 of a down payment to take over his property subject to the existing financing, and then two years down the road, interest rates take a big jump up, it's very possible that banks might start investigating their lower interest rate loans.

Not likely but possible, and it's not like the interest rates are going to skyrocket overnight. But in the event that they did, I mean, if you can't sell the property right away, they could accelerate the loan and take the property back of which say, you know, you'd say goodbye to your 50,000 bucks. So if it's a short-term strategy, go for it. If it's a long-term strategy, just be careful of how much you put into the deal up front. You do that, hey, there's really nothing to be afraid of. The due-on-sale clauses could essentially be.

your friend. It could be your secret weapon because it scares so many other investors away, but now you know how it works. You know the history and you know it's not illegal, it's not unethical, it's not fraudulent, and the likelihood of anything going wrong as long as you do everything right and you make your payments is very, very slim. So,

hopefully, I've cleared the air a bit and dispel some myths around how to invest subject to and overcome and beat that due-on-sale clause. I mean, it's an awesome strategy to having your tool belt, but it does you no good unless you actually use it. So now I'm assuming you are now armed with enough information about subject to and due on sale clauses that you can make an educated decision for yourself whether this strategy is for you or not.

Now, if I've left you with some questions or if you have questions about anything real estate related, I'm inviting you. I'm extending a personal invitation to attend the Epic Pro Academy coaching call on Monday, March 5th at 7 p.m. That's Pacific Standard Time. Monday, March 5th at 7 p.m. Pacific Standard Time. This is a private call. It's not open to the public. It's for Epic Pro Academy members only. But if you'd like to attend, I'd be glad to put you on my guest list,

then you can be my personal guest. Okay? So go register at Epicprocoaching.com. Epicprocoaching.com. And you can get the details of the call there. And you can attend either via phone or online via webcast. And that's at Epicproaching.com. And you can be my personal guest.

Okay, that's all I've got for you today. So until next time, as a very wise person once said, education is not the filling of a pale, but the lighting of a fire. To your success, I'm Matt Terrio, living the dream. Thank you for spending this time with Matt Terrio and the epic real estate investing podcast. When you have a moment, stop by iTunes to leave your comments and let us know what you think of the show. And if you haven't done so already, get started investing today by visiting free real estate investing course.com. To access Matt's free course, how to do deals, no money required.

Until next time, to your success. This podcast is a part of the C-suite Radio Network. For more top business podcasts, visit c-sweetradio.com. Thank you.