Subject To Financing: Traditional vs. Land Trust by Gary Mialocq, PhD

Subject To Financing by Gary Mialocq, PhD

The Traditional Way vs. Using a Land Trust

"Subject to" financing is very popular among small investors. When you purchase a property "Subject To", the existing loan stays in your seller's name. In other words, the seller leaves his current loan on his property in place and makes it available for you and then your buyer's use. You become the owner of the property when the seller transfers the deed to the property. There are two ways to accomplish "Subject to" financing: One is through the traditional (old-school) method described above, the second is with the use of a land trust, a method of investing used predominantly by the wealthy since 1891.

DUE ON SALE CLAUSE

One big failing of the "subject to" method of financing is that it is a violation of the Lender's Due on Sale Clause -- ALWAYS. In 1982, after a long battle with consumer groups, the Banking industry was able to get the Garn-St. Germain Act passed by Congress giving banks the right to call loans due if title is transferred as described above.

A lender may require any successor or transferee of the borrower to meet customary credit standards applied to loans secured by similar property, and the lender may declare the loan due and payable pursuant to the terms of the contract upon transfer to any successor or transferee of the borrower who fails to meet such customary credit standards. There is no lender permission in a traditional "Subject to" transaction, so there is no argument that ALL traditional "Subject to" financing transactions are DOS clause violations.

Even "Subject to" so-called guru, John $Cash$ Locke (I am suspicious of an ex-salesman who uses a $ in his name), warns: "Today almost all loans include a Due on Sale (DOS) clause whereby the lender can call the note due and payable upon transfer of the property to someone else. I felt this area of 'Subject To' should be covered, as it is a risk inherent with 'Subject To' investing, but certainly one that has not concerned me. However, you should be prepared to address this situation should the need arise by re-financing or building your Trust Account up... There are risks in all forms of real estate investing if not done properly. "Subject To" is no different."

The fact is that John purchased his supposed 500 homes during a time when interest rates were the lowest in decades so there was little chance of the DOS clause being invoked. Now with skyrocketing gas prices and rising interest rates, his "What, me worry?" stance looks very precarious. Here is what Land Trust expert Bill Gatten, creator of the Equity Holding Trust System™ used exclusively by his over 3500+ member North American Realty Services, Inc, says about the DOS clause:

"As far as the Due-on-Sale issue is concerned, the DOSC is definitely a threat and I couldn't care less about what anyone says to the contrary...they are wrong. It is indeed thing to be reckoned with and avoided when possible. Sure, most lenders will look away when the market is hot and interest rates are low; and if one can sell or refi if the note is called, then the DOSC is not of much concern. However, like many of my students, in my first several years in this business I had no credit or money and would have been in very deep piggy-poo had I received any more foreclosures than I did (lost two properties to due-on-sale calls in the early years). Furthermore, I have recent foreclosure demands on file from Countrywide and Washington Mutual that were thwarted by our explanatory letter indicating that the subject properties had not be sold, but were merely vested in inter vivos trusts and being leased to one of the beneficiaries."

LAND TRUST DOS CLAUSE EXEMPTION

Using a land trust for the purpose of a "Subject to", is exempt from the DOS Clause. According to Title 12, Chapter 13 § 1701j-3 Preemption of due-on-sale prohibitions:

(d) Exemption of specified transfers or dispositions

"With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home, a lender may not exercise its option pursuant to a due-on-sale clause upon-- (8) a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property; The NARS Trust always has the seller remaining as a beneficiary and the trust itself makes no reference to occupancy, hence, it is compliant with the DOS Clause.

So, we have differing opinions as to the danger of violating the DOS clause. Let's see what other differences there are that distinguish using a land trust from a traditional "subject to".

TITLE IN YOUR NAME - PRIVACY AND PROTECTION

With a traditional "Subject to", you take title in your own name. With a land trust, your Trustee holds title and your name appears nowhere on public records.

There are more than 80 million lawsuits filed in America every year. Property owners, landlords and real estate investors are susceptible to liability. Are you a target? Are your assets easy to locate? Is your real estate in your name? Why would you expose your most valuable assets to public scrutiny? Anyone can enter the county recorder's office and find the owner of any property. Real estate records are computerized, so your real estate holdings can be located at a moment's notice, If there are mortgages on your property, they will also be recorded and state the amount of the original principal balance and the date the mortgage payments began. Anyone can figure out your mortgage balance and subtract that amount from the market value of your house. They know how much equity you have and whether you are a suitable candidate for a lawsuit.

A contingency-fee lawyer charges a percentage of whatever he collects. Most contingency-fee lawyers refuse to accept a case unless the defendant has means. If you have no real estate in your name, chances are they won't take the case. Having the appearance of owning nothing is the best lawsuit-repellent you can have, and that is provided by the privacy features of a land trust.

PROTECTION AGAINST LIENS & ENCUMBRANCES

What happens if a judgment is filed against you in any county where you own real estate? I'll tell you. All of the real estate in that county will wind up having a lien attached to it. This means that you will be unable to sell or refinance any property since no title insurance company will guarantee a clean title.

There are those who use a corporation to hold title to real estate. They will not protect your property. If you own all of your properties in one corporation, a judgment against the corporation will create a lien on all property owned by the corporation. To make it worse, the directors and officers of a corporation are public-record, so your ownership will not be hidden. Should a judgment be brought against you and filed in any county in which you own real estate, all of the real estate in that county will wind up having a lien attached to it. This means that you will be unable to sell or refinance any property in that county, since no title insurance company will guarantee a clean title. The bottom line would be that you're stuck until you pay off the lien.

Corporate stock is considered an "investment". Investments are available to satisfy judgment creditors if you are personally sued. So you rear-end someone, get sued, and lose, they get your investments and suddenly they own the corporation and all of its assets.

Member interest in an LLC is considered personal property by statute. As such it is not available to satisfy a judgment creditor. You lose the case, but the best they get is a charging order against LLC income, which you can frustrate. Meanwhile, you remain owner and in control of the LLC's assets. Both the S-corp and the LLC protect you from liabilities arising from within the company. Only the LLC protects the company from your personal liabilities.

The ONLY deficiency of the LLC is that it protects your personal assets but leaves the real property partitionable and subject to liens and encumbrances. Place your property in a land trust with title in your LLC and you are rock solid.

A land trust is the solution for holding title to real estate. It is a revocable, living trust which is used to title ownership of real estate. The title to the property is held in the name of a trustee. This trustee is forbidden to reveal the beneficial owner. The beneficial owner (also known as a "beneficiary") can be an individual, a corporation or any other entity for further protection.

THE IRS

A land trust is considered a revocable "grantor" trust, so it does not require a separate tax identification number or income tax return. Therefore, you continue reporting the property for income tax purposes as though you still own it.

DEFAULT WITHOUT RECOURSE

A land trust allows you to assume a loan without recourse, a traditional "Subject to" does not. Few investors realize that such an assumption is with recourse. Should the investor sell the property and the buyer assumes and then defaults on the loan, the investor (and anyone else who previously assumed the loan) may be held liable. If a land trust is established to take title to the property and assume the loan, there is no recourse against the beneficiary. Additionally, the loan will not appear as a liability on the beneficiary's credit report.

"SUBJECT TO" UNDER LEGISLATIVE ATTACK

Many states are considering anti-small investor legislation and are especially focused on this type of financing. In North Carolina, HB725 which is very near passage will make "Subject to" financing illegal unless done by a licensed Realtor. Land trusts are exempted. There are several other states considering similar legislation, and Texas recently passed a law against lease options, making them illegal unless you own your property free and clear.

SUMMARY

* A traditional "Subject to" acquisition, is a violation of the DOS Clause. * A traditional "Subject to" provides no privacy or asset protection. Because title is in your name, you are a target for lawsuits. * A traditional "Subject to" provides NO protection against liens and encumbrances. * A traditional "Subject to" comes with liability in case of default by the buyer. * A traditional "Subject to" comes with ever-increasing legislative scrutiny and is subject to varying laws from state to state.

* A land trust is exempt from the DOS Clause. * Because title is in your Trustee's name (not yours) you are not a target of lawsuits. * A Land Trust provides solid protection against liens and encumbrances. * A Land Trust provides no liability in case of default by the buyer. * A Land Trust provides comes with the protection of Federal Law and is legal in all 50 states, though less effective in TN and LA due to their treatment of the trust as real property.

The concept of a land trust and what distinguishes it from any other type of investment or asset management strategy, is the Doctrine of Equitable Conversion. This is what enables us to convert real property to personal property. Once you have placed your property in the trust and deeded title to your Trustee, your transaction is no longer governed by mortgage law and all that goes with it including public recording of your documents. You are now governed by the Uniform Commercial Code (UCC), Article 9. This provides all the privacy and asset protection needed and sets the land trust apart from other investment tools.

You can avoid all the pitfalls of traditional "Subject to" financing and accomplish the same objectives with a land trust. Creating a trust is easy, inexpensive, and the best thing you can do to protect your home. If you rent or lease your property, the importance of asset protection and proper asset management is that much greater.

Copyright @ 2006 Gary Mialocq, Ph.D. All Rights Reserved.

About the Author
Gary Mialocq, Ph.D. is a former self-employed vocational rehabilitation counselor with significant experience in helping others improve the quality of their lives, having worked with disabled children and adults, juvenile felony offenders, and industrially-injured workers. He has also dabbled in real estate since 1980 using creative financing strategies and techniques to acquire and manage properties and is now a Full-Time Investor, Consultant and educator.