Lease Options vs.
Subject Tos
When to consider each technique
Acquiring investment
real estate can be handled with many approaches. Two
very popular zero down approaches are lease options
and "Subject To" also referred to as "Getting the
Deed".
A lease
option is a technique which involves gaining
'control' of a property, but not ownership - just
the right to possess a property now and purchase
that property at some future date with terms you
define today.
A
"Subject To" is getting the deed to a property
without getting a new mortgage. Instead, the seller
signs over the deed to his or her home 'subject to'
the existing mortgage staying in place. The buyer in
this case makes the mortgage payments on the old
loan, but does not get a mortgage themselves to
acquire this home.
Both of
these techniques usually require little or no money
down. In both of these techniques it is possible for
the buyer to get money from the seller or the
purchaser (or both!) in the beginning of the
transaction. These techniques, when used properly,
can provide for huge profits. They are both awesome
strategies, and when used hand-in-hand by investors
are almost an unbeatable pair!
This
short article is not meant to give details of each
technique, but rather to show when you should
consider each. If you don't understand how to
document and protect yourself in each kind of
technique, then purchase a course on the technique,
or do additional research.
Why
Knowing Both Techniques Means More Great Deals For
You!
Unfortunately there are many people that are
teaching that you should only do the subject to -
only get the deed deals. They recommend never buying
on an option. I can't tell you how many times I have
heard, "If I don't get the deed, I don't do the
deal". With 19 year's of experience (since 1985)
doing both types of deals, I have to disagree with
that statement. The more tools and techniques and
ways you have to purchase property or to structure a
deal, the more likely you will be able to work with
a motivated seller to come to a potential solution.
If you only buy "Subject To", you'll walk away from
a LOT of great deals in your real estate career -
but you must know when each technique is appropriate
to use.
Finding
a motivated seller is the first step to any good
real estate deal. There are many types of motivated
sellers, but we tend to think of motivated sellers
as the ones that are financially distressed. I like
to look at motivation from a much wider range. Let
me explain. I like to divide motivated sellers into
two groups:
|
Situation
Sellers that have Bad Debt
Solution
Get the Deed - NO Lease option! |
VS. |
Situation
Sellers that have
Good Debt
Solution
Lease Option or
Deed! |
|
Sellers that have 'Bad Debt', are those in trouble. They
might be behind on a mortgage, have lost their job,
acquired an illness, going through a divorce, etc. In
these situations, you need
to get the deed either with a subject to
or an outright purchase. Your main concern is that this
type of seller will continue to have financial problems
that could affect the title to "your" property if the
deed is still in their name. For example, if this seller
gets judgments from creditors, they can attach to any
real estate the sellers own - and they will have to be
paid off before you could exercise your option to buy.
That's why you want to get this type of seller off of
the title.
Sellers that have 'Good Debt' are those NOT "in trouble" in the traditional
sense, but they do have a reason motivating them to sell. Their problem is
not financial desperation - it's simply a change in their life. They might
be transferring to a new location for a promotion, getting married (each
owning their own home), building a new home, burned out landlords, etc.
Example #1: Here is an example
when you MUST get the deed:
A
seller calls you on the phone and says he is 2 months behind on payments.
Do NOT option this home! This seller
is in trouble financially and is not a good risk for an option. Anyone that
is in a bad financial situation is not a good seller for an option. This is
the type of seller that you must get off of the deed so that his financial
situation will not affect the title to the property in the future.
Not
every seller who is in financial trouble will tell you so, which is why you
ALWAYS need to do research on the title before you get the deed or do an
option. In this case, you will need to bring the seller's mortgage current.
Before you do, you will want to make sure that he/she is the owner of the
property and there are no other liens on the property unknown to you.
Example #2: Here is an example
when you COULD get the deed:
A
seller calls you who owes $135,000 on his home - which is worth $135,000.
Since he has no equity at all, this type of seller might very well be
willing to give you the deed. And if there is high appreciation or a very
low payment, you might be able to make a profit even though there's no
equity.
On the
other hand, if the seller's payment is too high or the market is slow, you
might need to have the seller pay you to take the deed. Yes, there are
sellers who will pay you to take
the deed to their home. Think about it: if this seller sells conventionally
- that is, though a Realtor, he would have to pay up to $10,000 in
commission to sell his home. Plus, he'll have closing costs, transfer taxes,
and will probably pay points or fees on behalf of his buyer. If he's willing
to pay all this money to an agent to sell the property - and wait 90-120
days to sell, too--why shouldn't he just pay you to take over his payments
NOW?
If the
seller didn't have the cash to give you, an option would be your best
strategy. This way, the seller can pay you the $10,000 over time, or you
could arrange for the seller to pay part of the monthly payment during the
option period. This way, if he stops paying his portion of the payments, you
have the choice of surrendering your option and simply giving the property
back to him. When you have the deed, you can't do this.
Example #3: Here is an example
where you SHOULD lease option or lease purchase:
A
doctor has a new home built for himself. His old home is worth $200,000 and
he owes $125,000. He has $75,000 of equity. He is not behind on payments,
and he did not need the $75,000 cash out to buy the new home. His old home
is sitting vacant and the realtor has not sold it yet. He qualified for both
house payments at the bank and he can technically afford both, but who wants
to make an extra house payment?
Although he is motivated to sell because he's coming out of pocket every
month to own a vacant property, this type of seller is NOT going to simply
give you the deed and let you take over the mortgage. No way is he going to
give up all of his $75,000 in equity, and no way are you going to pay that
much cash out of pocket.
When
you lease/option this house, he gets most of his equity back - although it
won't happen until YOU sell the property. The deal might work like this: you
option the property for $195,000, and make payments to the seller that
equals his total mortgage payments. You SELL the property on an 18 month
lease/option for $228,000 with payments to match his payments. You get cash
flow + $33,000 in profit when your tenant/buyer buys the property; the
seller gets his payments taken care of for a few years, then gets the bulk
of his equity out. And in the meantime, he doesn't have to worry about
management, vandals, frozen pipes, and all of the other things that owners
of vacant houses have to deal with.
Example #4: Here is an example
where you COULD lease option or lease purchase:
Seller
just inherited a property worth $120,000 from their parents estate. It is
owned free and clear and they don't want to be paid off. They don't need the
cash, but they would love some cash flow on this asset. This seller is not
going to give you the deed. Let's say you can lease option this property for
$700 per month with $300 per month going to the purchase - or the option
credit. Your real payment in this case is only $400. You also could do
seller financing on this property.
Let's examine a seller financing
deal:
A seller
financed deal means that the seller will finance a
mortgage for the buyer and the buyer pays their mortgage
payment and interest to the seller versus a bank. This
is primarily done when the seller owns a home free and
clear and they do not have a mortgage on it
themselves. Let's say you negotiate a deal with the
seller for a sales price of $110,000 - if you want your
payment to be $700, as in the above lease option
example, let's see what that really means to a seller
for a seller financed deal. First in a seller financing
or mortgage your payment includes taxes and insurance
(unless the buyer pays them themselves). This must be
subtracted from the $700. Each part of the country
fluctuates, so I will use an estimate of $250 per month
for taxes and insurance. This leaves $450 for the
seller. Now we must subtract our principal we
negotiated above the $300 per month credit. This now
leaves the seller with $150 per month. If this were to
be all that is left this would essentially mean the
seller is receiving 1.6-1.7% interest on their money.
The interest rate has to be disclosed on the loan
document or seller financed deal. A very low interest
rate is much harder for a seller to accept then a lease
option payment of $700 per month. It is the same thing
to the seller, but it is spelled out differently. They
don't do the subtraction themselves to calculate the
real rate of return. When you do a seller financing
deal, you must calculate and show the interest rate in
writing.
Let's examine the pros and cons of
Subject to vs. Lease Options - primarily as compared to
one another.
|
Subject to Pros: |
Subject
to Cons: |
|
Title is in
your name - Full ownership |
You own it and
have ethical responsibility to the seller
even if the market changes or you can't sell
the home. You own it! No changing your mind
on this one. |
|
Some sellers
will pay you to take the deed. |
You will need
to keep two insurance policies in place.
One that goes to the lender with the old
owner on it - so it won't trigger the �due
on sale' clause and one policy for you as
the real owner. You must insure it based
on the title or you will have no coverage.
This increases your real monthly costs. You
can also place it in a Land Trust to avoid
most of the due on sale issues - usually
recommended. |
|
Easier to
prove �seasoning of title' - when you are
the title holder. Easier to refinance.
|
In some states
mortgage brokers and realtors could be fined
and/or subject to revocation of their
license. It could be considered against
their code of ethics to assist a person in
violating a clause in a contract.
|
|
If you are on
the title you will have long term gains vs.
short term if you hold the home for longer
than 12 months. |
Sellers with
lots of equity will be hesitant or
completely against giving the deed.
|
|
Lease Option
Pros: |
Lease Option
Cons: |
|
You don't have
to buy later - if the market drops or there
is something wrong with the home. You can
get out! |
Title is NOT
in your name - seller
could screw it up - must
be careful to screen the seller. Only
lease option from strong sellers, not those
in trouble or headed for trouble. (unless
you put the deed in a Land Trust) |
|
More sellers
will do an option vs. giving up a deed -
especially on �pretty' homes.
|
You will have
short term capital gains vs. long term if
you are not on the title. This can be
avoided if you finance it with the 12 months
of payments (see the pros) and get on the
title and hold it for 12 months before
closing with your tenant buyer. This is a
minimum of a 24 month solution.
|
|
After 12
months of payments there are many lenders
that will treat a lease option as a
refinance - as if you were on the deed. It
would be treated like a land contract or
contract for deed refinance.
|
Some sellers
might feel like an 'option' is not closure
on their home. Some sellers will feel
better with a deed being transferred or a
lease purchase (which is a guarantee vs. and
option). |
|
A way to get
nicer homes. It is more likely the seller
that is not behind has taken better care of
their home. This type of seller is also
more likely to consider a lease option vs.
signing over the deed.
|
|
|
Seasoning of
title will start when you file a memorandum
of option or lien of interest. Most
lenders will consider this adequate and
similar to recording a deed. (with the
exception of FHA) |
|
|
Sellers with
lots of equity are more likely to give you
the right to buy the home than they are to
give you the deed to their home. |
Sellers with
lots of equity usually want to close and get
their equity out. |
Warning:
There are many factors to consider when making an offer
with either of these techniques. What is the current
market condition for real estate in your area? Are
homes appreciating, depreciating, or staying flat? What
is the financial condition of the seller? Are they
moving up or down financially in their new home? All
of these items make a huge difference on how you will
structure a deal. I always say - "Strong market - make
a stronger offer. Weak market - make a weaker offer".
Do your research,
but if you keep your mind open to new ways of acquiring
real estate, you will indeed make more money!!!!!
Wendy Patton is widely
recognized as one of the most inspiring speakers on "Little
or No Money Down" real estate investing. Her real estate
savvy and great depth of experience and knowledge has helped
her in orchestrating the most complete and easy to follow,
Lease/Option Program in circulation.
Home Study Courses by
Wendy Patton
|
