Subject-To vs. Novation: Choosing the Right Real Estate Strategy
When to use subject-to and when novation makes more sense for your deal.
Austin Beveridge
Tennessee
, Goliath Teammate
When navigating the world of real estate, understanding the best financing strategies can feel overwhelming. Two popular methods, Subject-To and Novation, often confuse buyers and investors alike. Knowing when to use each can save you time and money while maximizing your investment potential.
Quick Answer
Subject-To is a strategy where a buyer takes over the seller's existing mortgage payments without formally assuming the loan, making it ideal for quick acquisitions with minimal cash. Novation, on the other hand, involves replacing the original contract with a new one, which is useful for transferring ownership and liability. Choose Subject-To for speed and flexibility, and Novation when you need a clean slate and clear title.
Understanding Subject-To
Subject-To financing allows a buyer to acquire a property while leaving the existing mortgage in the seller's name. This can be advantageous for buyers who may not qualify for traditional financing or who want to avoid lengthy approval processes.
How Subject-To Works
In a Subject-To deal, the buyer makes payments directly to the lender, but the mortgage remains in the seller's name. This means the seller is still responsible for the loan, but the buyer benefits from the property.
When to Use Subject-To
When the seller is motivated to sell quickly, often due to financial distress.
If the existing mortgage has a low interest rate that is beneficial to the buyer.
When the buyer lacks sufficient credit or funds for a traditional mortgage.
Example Scenario: Subject-To in Action
Imagine a homeowner, Jane, who needs to sell her house quickly due to job relocation. She has a mortgage balance of $150,000 at a low interest rate. A buyer, Mike, approaches her and proposes a Subject-To deal. Mike takes over the payments, allowing Jane to move without the burden of her mortgage, while he benefits from a favorable loan.
Understanding Novation
Novation is a legal process that replaces an old contract with a new one, effectively transferring obligations and rights from one party to another. This strategy is often used when a buyer wants to assume a mortgage officially.
How Novation Works
In a Novation, the original contract is voided, and a new contract is created, often requiring lender approval. This means the seller is released from the mortgage obligation, and the buyer assumes full responsibility.
When to Use Novation
When the buyer wants to ensure they have clear title and responsibility for the property.
If the seller is not in a position to continue making mortgage payments.
When the buyer has the creditworthiness to qualify for a new loan.
Example Scenario: Novation in Action
Consider Tom, who wants to buy a property from Sarah. Sarah's mortgage is $200,000, but she cannot continue payments due to financial issues. Tom approaches the lender to novate the loan, creating a new agreement that releases Sarah from her obligations. Tom now holds the mortgage and can manage the payments directly.
Checklist for Choosing Between Subject-To and Novation
Assess the seller's motivation and urgency to sell.
Evaluate the existing mortgage terms and interest rates.
Determine your creditworthiness and ability to secure financing.
Consider the legal implications of each strategy.
Consult with a real estate attorney or expert for advice.
Common Mistakes to Avoid
When considering Subject-To or Novation, avoid these pitfalls:
Not fully understanding the existing mortgage terms can lead to unexpected liabilities.
Failing to communicate clearly with the seller can cause mistrust and complications.
Overlooking the need for lender approval in Novation can derail the process.
Neglecting to consult with a real estate professional can result in missed opportunities or legal issues.
FAQs
What is the main difference between Subject-To and Novation?
The main difference lies in the ownership and liability transfer. Subject-To allows the buyer to take over payments without assuming the loan, while Novation officially transfers the mortgage to the buyer, releasing the seller from liability.
Can I use Subject-To if the mortgage is in default?
Yes, but it can be risky. If the mortgage is in default, the lender may initiate foreclosure proceedings. It's crucial to evaluate the situation carefully and consider the potential consequences.
Is Novation always required for transferring a mortgage?
No, Novation is not always required. If the buyer is taking over payments without formal assumption, Subject-To may be a better option. However, Novation is necessary when the buyer wants to assume the loan officially.
Are there any costs associated with Subject-To or Novation?
Subject-To typically involves fewer costs, as it doesn’t require lender approval. Novation may incur fees related to closing costs and potential lender fees for processing the new loan agreement.
Can I change my mind after choosing one strategy?
While you can change your approach, it may involve legal and financial implications. It’s best to decide based on thorough research and consultation with professionals before committing to either strategy.
