Here’s the best-kept secret of the last thirty years: You CAN buy investment real estate with no money down and no credit. The secret comes from understanding WHY mortgages contain “due on sale” clauses and WHEN lenders won’t enforce them.
Before 1980 or so, it was common for people to sell their property, and the new owner would just take over the mortgage payments. The seller either received cash for their equity, or took back part of the financing with something called a “wrap around mortgage.” Everything was fine until the federal government de-regulated the maximum interest rates that could be paid on savings accounts and CDs.
Typically, savings and loans originated mortgages and kept them until paid in full. S&Ls received interest income from the loans, and they paid interest on savings accounts. If competition forced them to pay 12% interest on savings, they’d get killed if assumable mortgages continued to earn only 6%. To solve the problem, lenders added due on sale clauses to mortgages. With such a clause, lenders were able to demand payment in full whenever a property was sold. It became virtually impossible to buy a property “subject to” an existing mortgage.
Fast forward to today. In this environment, do lenders WANT to “call” a mortgage loan and force default, foreclosure, write-offs? Of course not. If a property owner could not make his or her payments, would you be a HERO if you bought the property and started making the payments? Of course you would!
The due on sale clause is not usually automatic. The lender has the right to call the note. They don’t have to, if they don’t want to.
You should target properties advertised as “possible short sale” or similar words. Sign a purchase contract that includes a contingency for lender forbearance from exercising the due on sale clause AND an agreement to tack past due payments onto the end of the mortgage term.
Explain to the seller that this will be “subject to” and not “assumption.” With an assumption, the lender typically releases the seller from liability on the promissory note, but adds the buyer. With “subject to,” the seller still remains liable on the note and the buyer’s name is not added. In other words, with a “subject to” sale, timely payments by the buyer show up on the seller’s credit report. Past due payments by the buyer will hurt the seller’s credit. If the buyer defaults, the foreclosure will show up on the seller’s credit report. If the lender sues for a deficiency after a foreclosure, it will sue the seller, not the buyer.
In a “subject to” transaction, the buyer is invisible as far as the loan is concerned. Selling property subject to a mortgage requires a great deal of faith and trust, or a great deal of desperation. I think many sellers today are desperate for a chance to preserve their credit, for an opportunity to avoid the humiliation of foreclosure, and for freedom from lender’s collection calls. I think many lenders are desperate to keep performing loans on their books but can’t allow true assumptions because of outdated regulations. It is the perfect time to invest with no money down and no credit.
One last piece of advice: Don’t try to hide this from the lender. Be up front and honest. You both want the same thing: a performing loan. Good luck, and good investing!