One of my favorite ways to buy houses when a seller will not immediately deed their home to me is to lease/option it initially and then convert it to a “subject to” later on. Almost none of your competitors are aware of this awesome strategy. This seems to be one of the best kept secrets in the real estate business. Sometimes a seller just doesn’t trust you enough to want to deed you a property immediately while the mortgage is still in their name, but they are willing to lease/option you the property and let you make monthly payments. This gives them a sense of security until you prove yourself.
Let’s define the difference between a lease/option and a “subject to” deal. When you lease/option a property from a seller, you want to do it with no money down if possible. I have a really hard time putting any money down on a property I don’t own from the start. The mortgage and the title stay in the seller’s name until you exercise your option and pay off the mortgage. So you control the property, but you don’t own the property. When you do a long-term lease/option agreement with a seller like I do, you also realize the long-term appreciation of the property as well.
When we get a property “subject to” the existing mortgage, this means the seller simply deeds us the property and we now own it. What that means is that while you now own the property, the mortgage remains in the seller’s name until you pay if off by selling the property. The insurance on the property now converts to you and the seller since you own it and the seller still has a mortgage. But at this point you also have all the tax benefits that go with owning the property. This is always the best way to purchase a property if you can.
While neither strategy is necessarily better, there is certainly a time and place for both strategies to work for you. Usually you are always better off getting the deed, but sometimes this is just not possible for a variety of reasons. At that point, buying on a lease/option is another strategy that can work just as well for you, and you will probably find that in more cases a seller is more willing to lease/option a property to you as opposed to deeding it to you. When you get the deed, you never have to worry about the seller putting additional debt on the property or going bankrupt. One way I protect myself from the seller adding any additional debt on a property is to record my option immediately.
So how do we convert a lease/option deal to a “subject to” deal? This is the way we do it. First of all, we use our own lease/option paperwork so all of the parameters of the deal are exactly as we would want them. The lease and the option are always separate. Additionally, the amount of the monthly payment due is the mortgage payment on the property and we make that payment directly to the mortgage company instead of to the seller. The seller provides us with their payment book or they have the monthly statement sent directly to us.
The way I explain this to my sellers is simple. I let them know that since we have an equity interest in the property, we want to be assured that our payment is indeed going to the mortgage company each month. We also volunteer to send a copy of our check to the seller so they know we made the payment in a timely manner. This lets our seller know that we are doing exactly what we said we would do. Our lease/option is for one year with the right to extend for an additional period of five years. There is no option deposit at the beginning, or at any of the extensions. I will never put money down on a property unless I own it. We also have the seller provide us with a current title search in order to make sure there is no other debt or liens outstanding on the property at the time we lease/option it and we make sure mortgage payments are current. Many times, we are able to lease/option the property for just the mortgage balance or maybe just a few thousand more than the mortgage balance.
Sometimes during the course of our lease/option period the seller will come back to us and ask us if there is any way we can just cash them out now. If that happens, that usually means a discount to me on the price of the property if I owe the seller some cash. Usually I will say to the seller I hadn’t really thought about cashing out you out early, but if I could get a discount on the price of the property, say $10,000, I might be inclined to see what I can do for you. Remember, many times, I lease/option the property for just the balance of the mortgage, even though the home is worth more, so in this scenario we just have the seller wait until the lease/option expires unless there is a way we can cash them out early, like if our tenant/buyer is ready to get refinanced.
The seller is also responsible for any repairs over $200.00 so any major maintenance or repairs are still the seller’s responsibility. If you do discover that there is a major repair needed to the property, say a new roof, this becomes a good time to just have the seller simply deed you the property and allow you to handle the problem.
For example, I simply tell my seller, “We have discovered that the house needs a new roof and it is going to cost $5,000 to replace. I have an estimate here for it. That means you will be responsible for $4,800.00 of the repair. If you will simply deed me the property so that I own it, then I would be more than willing to handle this repair. Is that fair?” Many times this will push the seller into simply deeding you the property. You are trading the deed for the amount of the repair. Once again, I would not pay for a repair of that size without owning the property.
I also have the right within the confines of the contract to rent, lease/option or sell the property as I wish, giving me total control as to what happens with the property. I then have a conversation with my seller to warm them up to the idea of me eventually getting the deed to the property.
I have this conversation with my seller right at the beginning. It goes something like this. “While I understand that you are uncomfortable deeding your home to me at this time, I would like to revisit this issue after I have proved to you that I intend to keep up your payments and make them in a timely manner.” Is that okay with you? They almost always say yes. In fact, there are times that sellers will contact us in the interim and they just want to be done with it, so they will deed us the property at that point. Remember, these are motivated sellers we are dealing with. After about three to four months, I contact the seller again, letting them know that we have indeed made all of our payments on time and that we have a renter or tenant/buyer or whatever in the property. We then ask them again if they are willing to simply deed us the property. We remind them at this point that if they simply deed us the property, they will not have a lot of the closing costs they would otherwise have. Also, if I promised them any money for part of their equity, we usually pay part of that to them at the time they deed us the property. Usually this is a small amount of cash but it is an incentive to the seller. We also let them know that when they deed us the property, they are no longer responsible for any repairs that might arise.
When you get good at using this strategy it will work very well for you. We have converted many of our lease/option purchases to “subject to” deals this way. All it usually takes is a little bit of time to build a relationship with your seller based on trust. This strategy is especially powerful when the seller isn’t expecting any equity out of the property.
At the point that the seller deeds you the property, you need to go down to the courthouse and file a release of the option and then you need to file the new deed on the property. You will also place the property in a land trust at this point if you didn’t take it that way when you did the initial lease/option. You can check all of these matters with your real estate attorney or title agent. You then need to use all the regular paperwork you would anytime you take the deed from a seller.
Taking the effort to convert a lease/option to a “subject to” is an absolutely essential strategy to your business. The extra work involved is absolutely worth the end result which is that you own the property. So be on the lookout for situations where you can convert a lease/option purchase into a “subject to” deal.
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