Why Title Companies Are Steering Clear of Subject-To Transactions
Subject-to transactions, where a buyer takes over existing mortgage payments without formally assuming the loan, have been popular with real estate investors as a creative financing tool.
However, title companies have increasingly distanced themselves from these deals, especially those involving FHA and VA loans. The enforcement of HUD Circular Letter 7-90, issued on December 14, 1990, is a significant reason for this shift. The letter outlines the legal risks of bypassing the formal credit qualification process, which puts title companies at risk of penalties.
Legal and Regulatory Risks: HUD Circular Letter 7-90
HUD Circular Letter 7-90 prohibits title companies and real estate brokers from allowing property transfers with FHA-insured loans unless the buyer has undergone formal credit qualification. FHA loans originated after December 15, 1989, cannot be assumed without this step. Subject-to transactions that avoid credit checks may violate federal regulations.
Title companies involved in such transactions risk severe consequences, including suspension or permanent debarment from FHA and VA programs. Because of this increased enforcement, many title companies have begun avoiding subject-to deals altogether to protect their business from these legal and financial risks.
Suspension and Debarment: Potential Consequences
The penalties for facilitating subject-to transactions without complying with federal guidelines are significant. HUD enforces rules that could result in the suspension or debarment of title companies and brokers from participating in FHA and VA programs. Since these programs make up a substantial part of the real estate market, losing access to them can be highly damaging for any title company.
The Colorado Real Estate Commission (CREC) has echoed these concerns, warning title companies and brokers about the potential sanctions tied to subject-to transactions. This regulatory pressure has made title companies more cautious, favoring compliance with HUD rules to avoid costly sanctions.
A Possible Scenario
Consider a scenario where a seller agrees to a subject-to transaction because the property is upside down, meaning the loan balance exceeds the property’s value. The buyer takes over the mortgage payments but stops making them after a year, leaving the seller in a difficult position. The loan defaults, and the lender starts foreclosure.
During the foreclosure process, the lender discovers that the property deed was transferred to the new buyer without the buyer undergoing the FHA’s required credit approval. This discovery may expose the agents and title company involved to potential sanctions. The title company, which allowed the deal to proceed without the required compliance, could face suspension or debarment from federal loan programs. Both the real estate agents and the title company could be held responsible for circumventing the necessary regulations.
Impact on Real Estate Investors
Subject-to transactions have historically provided real estate investors with a way to acquire properties without securing new loans. However, the increasing regulatory risks have made these deals more challenging to execute. Title companies, facing potential penalties, are less willing to facilitate these transactions. As a result, real estate investors may need to explore alternative financing methods that comply with HUD regulations to avoid complications.
Conclusion
The reluctance of title companies to engage in subject-to transactions is closely linked to the enforcement of HUD Circular Letter 7-90. With the risks of suspension or debarment from FHA and VA programs, title companies are shifting away from these deals to remain compliant with federal guidelines. For real estate investors, this change limits the opportunities for creative financing options, requiring a greater focus on fully compliant transactions to avoid legal and financial challenges.
