Messing this up could cost you!
If you’re getting started with Subto (Subject-to) real estate deals, you’re likely aware that you’re taking over the mortgage payments while the seller’s loan remains intact (If not, check out prior posts on creative finance) . This creative financing strategy is powerful, but it also comes with important legal and financial responsibilities. One of the most important of these is having the appropriate homeowner’s insurance. If you do this incorrectly it could put the original seller and you at significant risk of being in dire straits.
What Is a Subto Deal?
To review, In a subto deal, you (the buyer) take over the responsibility of making the seller’s mortgage payments, but the loan stays in the seller’s name. While this arrangement can be a great way to acquire a property with little to no money down, ensuring the right insurance setup is crucial to avoid problems with the mortgage lender and protect the property. If you don’t do this correctly
- The original seller could be in big trouble if there is a problem such as a fire or other catastrophic event that requires the insurance to pay out.
- You could be in trouble for the same reason.
- Not having insurance could alert the mortgage company that the deed has transferred and trigger the due-on-sale clause (for more on that read here).
Step-by-Step Guide to Setting Up Insurance for a Subto Deal
1. Review the Existing Homeowner’s Insurance
The seller likely has an active homeowner’s insurance policy, but since ownership is changing hands (even though the mortgage isn’t), this policy will need to be modified or replaced. Don’t cancel the seller’s policy just yet—you’ll want to have a new policy in place before making any changes.
Questions to Ask:
- Is the current policy paid through an escrow account or is the seller paying separately?
- What is the coverage amount, and does it meet the lender’s requirements?
2. Secure a New Insurance Policy
As the new owner, you’ll need to purchase a new insurance policy in your or your LLC’s name. Since you’re not living in the property and may be renting it out or holding it as an investment, you’ll need a Landlord Policy (DP3).
This type of policy protects you against the unique risks of owning rental properties, including:
- Damage to the property
- Loss of rental income due to a covered event
- Liability protection for injuries or damages incurred by tenants or guests
3. Name the Mortgage Lender as an Additional Insured
Even though the seller isn’t paying the mortgage anymore, the loan remains in their name, and the lender needs to protect their interest. This means the lender must be listed as an additional insured or loss payee on the new insurance policy.
Why is this important?
In case of damage to the property, the lender will be protected by the insurance so they can continue to get paid even though the house is uninhabitable and not receiving any rental income during the repairs.
4. Include the Seller as an Additional Insured (or Interest)
In most Subto deals, the seller remains responsible for the mortgage, even though they’ve handed over ownership and payments to you. It is important that the seller also remains on the new policy as an additional interest or insured.
This ensures that the seller, who is still tied to the loan, is protected in case any claims arise before the mortgage is fully paid off or refinanced. It also lowers the likelihood of the due-on-sale clause being called.
5. Notify the Mortgage Lender About the New Policy
Once you’ve secured the new insurance policy, it’s time to notify the mortgage lender. Most lenders have specific requirements for proof of insurance, often referred to as an insurance binder. You’ll need to:
- Provide the new insurance details to the lender.
- Ensure that the lender is listed as a loss payee.
- Verify that the lender has updated their records with the new policy information.
Failure to notify the lender could result in forced-placed insurance, which is expensive and provides less protection for you. It also, just as above, might trigger the lender to start investigating the loan raising the risk of the loan being called due.
6. Cancel the Seller’s Existing Insurance (if applicable)
If the new insurance policy is active and properly set up, you can work with the seller to cancel their old insurance policy. However, it’s critical that this only happens after your new policy is fully in place to avoid any gaps in coverage.
7. Manage Escrow Payments (If Insurance is Paid Through Escrow)
If the mortgage lender is collecting insurance payments through an escrow account, you’ll need to coordinate with them to ensure that the escrow account reflects the new policy details. You may need to adjust your monthly escrow payment to cover the new insurance premium.
How to Handle Escrow:
- Notify the lender about the change in insurance.
- Confirm that they are paying the new policy premium from escrow.
- Check that any overpayment or underpayment is adjusted accordingly.
8. Review and Renew the Policy Annually
Setting up insurance isn’t a one-time event. Make sure you:
- Review the policy annually to ensure it still meets the property’s needs and your investment strategy.
- Confirm the lender’s requirements haven’t changed.
- Keep the policy active and make adjustments as necessary (e.g., if you convert the property into a short-term rental or make significant renovations).
Final Thoughts
Setting up insurance for a subto deal might seem complicated, but its really not so difficult. Following these steps will ensure that you’re fully covered and the mortgage lender’s interests are protected. Proper insurance is key to safeguarding your investment, complying with the lender’s requirements, and giving you peace of mind.
If you’re interested in learning how to get started in real estate investing while avoiding the hassles and complexities, schedule a Zoom call with us! We’ll show you how you can get into real estate investing with us doing all the hard work—allowing you to grow your wealth without the stress of managing properties or dealing with legal technicalities.
Grove Family Investments 
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