Real Estate investors – don’t start eyeing that Lamborghini yet! Lately, my inbox is flooded with emails touting the wonders of Mortgage Assignments as a real estate investment vehicle. Basically, these are “subject to” deals with a new name. And while “subject to” transactions serve a purpose – that purpose is narrow and should not be undertaken lightly. Remember, if something sounds too excellent to be right, it is.
I don’t quite know how these gurus can refer to their investing technique as a Mortgage Assignment. A mortgage assignment is a documents that transfers ownership of a mortgage from one Lender to another. A homeowner or mortgagor cannot transfer his mortgage – he doesn’t own the mortgage. He merely has the obligation to pay the Note holder.
Jeff Watson does a superb job dissecting an example of a “Mortgage Assignment” transaction in his blog post. Suffice it to say that the homeowner is left holding the bag when the deal falls apart. And fall apart it will. Without certain protections and limitations, these transactions are ticking time bombs. Unless, by some miracle, you are able to procure a release of liability from the mortgagee for the benefit of the mortgagor (homeowner), when, not if, the buyer stops paying the mortgage, the mortgagor is still liable for that note and now doesn’t even own or control the security. The investor pockets his assignment money and leaves himself exposed to a civil fraud suit or, possibly a criminal fraud action.
Mortgage Assumptions and the Due on Sale Clause
Most mortgages contain a “due on sale” clause which allows the mortgagee to call in the note and accelerate the debt if the mortgagor sells or transfers the underlying property. As such, if a buyer takes subject to the mortgage and agrees to make the payments, he could lose the house and his cash investment if the bank decides to exercise its rights under the due on sale clause. There are some narrow exceptions where the mortgagee cannot accelerate the note, such as the case where the mortgagor transfers the property to a trust but retains the beneficial ownership of the trust. That but, is a topic for another day.
Continuing Lien Deduction & Transfer Taxes
I have closed “subject to” transactions. It was a excellent fit where the homeowner was not underwater but still had a honestly high mortgage balance with some equity. The investor takes title to the premises, subject to the open mortgage, with an agreement in place that such mortgage would be paid off within a certain small time frame, i.e. 6 months to a year. This type of transaction can be benefit the homeowner as well where it eliminates or reduces the transfer tax burden. In New York, the homeowner reduces his transfer tax liability with the continuing lien deduction available under the New York State and New York City tax laws. Instead of paying transfer taxes based upon the buy price, the homeowner does not have to pay transfer tax on that part of the sale price equivalent to the principal balance of the continuing lien. The investor is pleased because he just secured free, small term financing.
Tell, Tell, Tell!
But, there must be full disclosure to the homeowner of the risks of such a transaction so as to avoid the “fraud” specter. To protect the seller, we always held in escrow a Deed and ancillary documents, executed by the investor transferring title back to the seller, so that if the investor should default on his obligations, title would revert back to Seller and the Investor would lose his cash investment. It provided the necessary incentive for the Investor to abide by the terms of the agreement. This Agreement was made a part of the Contract of Sale and survived delivery of the deed.
This type of transaction really cannot be treated as some sort of miracle long-term financing solution. Used correctly, subject to transactions can benefit all parties but if not, beware!
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