The Difference Between A Land Contract And A Subject To Deal
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Read Transcript for “The Difference Between A Land Contract And A Subject To Deal”
I spend so much time explaining this to my students: the difference between a land contract and a Subject To deal and the hierarchy of zero down real estate deals. Let me go through it again and explain the differences between them and what works and why in different situations.
“Joe, can you give some basic definitions for some of the strategies you implement? How can I explain the difference between a land contract versus a “Subject-To” versus a lease option, etc.? Thanks, Javier.” – Javier Pelanco
Joe: I’m going to try to make this quick. We spend two and a half to three hours on this at the Buying Event because this is the core information of what I teach – this is the most important part that you need to understand – structuring zero down deals. That’s what this is really all about.
Joe: If you understand what the hierarchy of these structures is, it’ll make it easier for you to look at a particular deal and say, ‘Yes, that deal needs to be structured in this way in order to make it work.’ Ultimately, what we’re looking for is a way to solve the problem of the seller. Also, we’re financing deals. All of these kinds of investment deals are about solving the problem for the seller, and when you solve that problem for them, then they’ll want to do the deal.
Joe: But it has to be solved in a way that makes profit for you. So, rather than talking about how we’re going to make a profit on it, I’m going to talk about how we’re going to structure the deals, the different structures that are available and the hierarchy that they should be in, and I’m going to try to do this in the next two to three minutes.
Joe: First of all, “Subject-To”: this is the top of the hierarchy. The way you buy the property “Subject-To” is the seller that has an existing mortgage on the property deeds the property to you. The loan stays in the name of that seller. You’re not assuming the loan. You’re not qualifying for the loan. You’re not even ever talking to the lender. All you’re going to do is start making the payments on it.
Joe: The deed is in your name because they deeded it to you – you’re going to take a warranty deed, and this puts you in full control of that property. Now, it’s still subject to the existing loan, so those payments have to be made, and it’s possible that the lender is going to take the property back if you default on it.
Joe: Now, there’s some other issues in this which need to be addressed I’m not going to get into it because we don’t have much time, i.e. due on sale clauses and things like that, but it’s not difficult. We do these types of deals all the time. This is the top of the hierarchy and this is the way that you want to buy properties.
Joe: The next type is “Multi-mortgage”. This is if a seller has equity. Let’s say they have a first mortgage of $100,000 but the property is worth $200,000. They’re willing to sell it for $180,000 but they don’t want to take an $80,000 loss, so what you do is take over the first mortgage subject to the existing loan ($100,000) and then you give them their equity as a second. So, they deed the property to you and then you borrow that other $80,000 from them in the form of a note and you owe them $80,000 to be paid over a period of time at a certain interest rate.
Joe: Obviously, you want the longer period of time. You want a shorter, lower interest rate, typically a five year period with a 6% interest rate in interest only payments. That’s the way you would set up a Multi-mortgage, and that gets their equity out. The other option they have is to refinance their property, pull their equity out that way, and then just sell it to you Subject-To. That’s the second tier in the hierarchy.
Joe: The third one is land contract, also known as contract for deed if you’re in a trust deed state. This is called purchase money, and this is when the seller stays on the deed – you don’t get the deed, so your position isn’t as strong. But you still get ownership and you’re going to be able to record this land contract.
Joe: A land contract is a document simply laying out the terms of your purchase, e.g. what the interest rate is, what the payment amount is, what the term of the loan is, what the purchase price is – all of those things are laid out on this document. This document is then recorded at the county recorder and it secures your position in this property. It’s a good way to buy property. I prefer Subject-To. I think it’s lower in the hierarchy than Subject-To.
Joe: The next one is lease option. You buy a property leased with an option to buy, so you’re leasing a property, paying a monthly lease fee and then you have an option to buy at a specific price for a certain period of time. So, if it’s a one year lease option, you have one year to exercise that option at that specific price. After that, the option expires and if you don’t buy that property within that period of time, then you lose your option and then it’s just the terms of the lease that have to be fulfilled. So, that’s the least secure way to buy property.
Joe: If you’re selling property, the hierarchy is reversed. You want to sell lease option first, because that gives your buyer less security and it puts you in a stronger position. You always want to keep the strongest position because you’re going to be the one that’s going to be the most responsible in this process, and if they default, you’re not going to be hurt as bad. Hopefully that answers the question.