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All over the country we are seeing residential real estate transactions involving taking the property "Subject To" the existing mortgage coming under greater scrutiny by the various Attorneys General. This method of conveyance has been used in the commercial real estate world since the early days of commercial financing. The use of this technique in the residential setting, however, is a fairly recent phenomenon. As a result, consumer protection activists are having a field day.
The first issue is the fact that many investors who acquire real estate subject to the existing mortgage (Sub2) do not follow through with making the monthly mortgage payments as promised. In fact it is this issue that has brought this acquisition technique onto the radar scopes of lawmakers and activists. The fact is that this mortgage payment should be handled like each of the buyer's other mortgage payments and paid on time as promised. The fact that it is not the buyer's credit rating that is in jeopardy should not be a reason for the buyer not to make the payments on time. If anything, the buyer should make an extra effort to make these payments because it involves the lives of others and not just that of the buyer. If you cannot do a subject 2 deal using this payment philosophy, you have no legitimate reason to be doing them at all.
The second issue is the fact that buyers have been drawing sellers into committing fraud by using land trusts and other instruments to hide the transaction. The stated reason for this commission of fraud is to avoid the alienation clause, commonly referred to as the "Due on Sale" clause. This comes from a provision in the Garn-St. Germaine act that states a lender cannot call the note due if the borrower transfers the property into an inter-vivos trust for asset protection purposes. The fact is that an inter-vivos trust is a revocable living trust, not a land trust. Using a land trust in this manner does not protect anyone from the lender calling the note due. Hiding the transaction under the guise of asset protection is fraud. Telling the homeowner to tell the lender they still own the property when they don't is also fraud. Another point to consider is that many also use land trusts and other instruments to avoid paying transfer taxes and stamps. Again, this is fraud. So if you are going to do Sub2 deals, keep them clean, don't commit fraud, and make sure you fully disclose the nature of the transaction and its risks to the seller.
This is the purpose of the Subject To Disclosure. This is disclosure of the risks associated with the transaction to the seller. Arguably, this is the best subject to disclosure available today. When my attorneys reviewed it, they all agreed that it was the kind of disclosure that would help buyers stay out of court, and if it didn't succeed there, it was the kind of document they would love to be able to dance and parade around the courtroom with shouting, "See, they knew! They knew!" One attorney told me the only thing missing was a statement stating the seller would be an idiot if he sold his home Sub2. The interesting thing about this level of disclosure is that it tends to promote trust between the seller and the buyer. By using this disclosure, not only are you disclosing the risks to the seller, but you are in fact building trust because the seller knows you are not running away from explaining these risks. It is the same if you were having a heart transplant. You know you can die from the operation. Who do you trust more, the surgeon who says you won't die, or the one who understands the risks and tells you that you could die, but he will do everything in his power to keep that from happening? You want the one who is more responsible and understands the risks. So does the seller.
This document is not a magic bullet. It will not guarantee you will not see the inside of a courtroom. But it is a pretty good suit of armor. Order it from the bookstore under general real estate documents today.
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