Seller Financing First, Sub2 Second
Before you learn sub2, understand this: seller financing is the cleaner deal in 8 out of 10 situations. When a property is free and clear, or close to it, you want a simple promissory note secured by a deed of trust - not a complicated subject-to arrangement. Sub2 only makes sense when there is an existing mortgage worth keeping.
What Is a Subject-To Deal?
A subject-to acquisition means you buy the property but leave the seller's mortgage in place. The deed transfers to your name, but the loan stays in the seller's name. You make the payments. The seller's credit is on the line.
This structure makes sense in one specific scenario: the seller has an existing loan at a rate you cannot replicate today. If they locked in a 30-year fixed at 3.25% in 2021 and you can keep that loan alive, you inherit a cost-of-capital advantage.
Example:
- Seller has $180,000 remaining on a 3.25% fixed note, payment of $783/mo
- Today's equivalent loan would carry a 7.5% rate - payment of ~$1,259/mo
- The payment gap is $476/mo, or $5,712/year
- Over a 5-year hold, that gap compounds to real money
That is the only reason to do sub2. If the rate advantage doesn't exist, negotiate seller financing directly.
When Seller Financing Wins
Use seller financing instead of sub2 whenever:
- The property is free and clear (no existing mortgage to assume)
- The existing loan rate is above 6% - no advantage to keeping it
- You want clean title and a simple capital stack
- You plan to refinance within 3-5 years (clean title makes DSCR refis easier)
- You are presenting to an unsophisticated seller who is confused by sub2
Most free-and-clear sellers are retirees, estate sales, or long-term holds who paid off their loans. These are your best seller-financing candidates. Do not complicate these deals with sub2 language.
The Sub2 Mechanics You Must Understand
In a true subject-to:
- **The deed transfers.** Your name goes on title at closing.
- **The loan stays in the seller's name.** It does not transfer.
- **The due-on-sale clause.** Virtually every residential mortgage contains a clause that allows the lender to call the loan due when the property is sold. Lenders rarely enforce it on performing loans, but the risk exists.
- **Insurance.** You must maintain hazard insurance. The seller's name should be on the policy as additional insured to avoid a "title transfer" trigger.
Run these sub2 scenarios in Woosung alongside the straight seller-finance scenario to compare true cash flow. Sometimes the inherited payment looks great until you account for taxes, insurance, and deferred maintenance.
Sub2 vs. Seller Financing - A Side-by-Side
| Factor | Seller Financing | Subject-To |
|---|---|---|
| Existing mortgage needed? | No | Yes |
| Loan in buyer's name | Yes | No |
| Due-on-sale risk | None | Present |
| Refi readiness | High | Medium |
| Complexity for seller | Low | High |
| Best for | Free-and-clear sellers | Low-rate existing loans |
The Practical Decision Tree
Ask yourself three questions:
- Is the property free and clear? **Yes - use seller financing.**
- Does an existing loan exist? **Yes - what is the rate?**
- Is the existing rate materially below today's market (2%+ spread)? **Yes - consider sub2. No - negotiate straight seller financing.**
If you are in a sub2 deal and the seller has equity above the loan balance, you can often structure a wrap - a new seller-financed note that wraps around the underlying loan. The seller carries the spread. But again, seller financing without an underlying loan is always cleaner.
Protecting Yourself in Sub2
- Always use a professional title company and real estate attorney.
- Record the deed promptly. Do not delay.
- Set up a loan servicer to auto-pay the underlying mortgage.
- Carry insurance from day one.
- Keep a reserve fund equal to 6 months of the underlying mortgage payment.
Sub2 is a legitimate tool. It is just not your first tool.