Subject-To on Underwater Homes: Math, Lists, and Trusts

Yes, a subject to deal on underwater homes can work — but only when the monthly gap between the mortgage payment and market rent is small enough that you’re effectively financing a down payment instead of bleeding cash. That’s the line Larry Steinhouse, a Philadelphia-area investor who rebuilt after going bankrupt in 2008, draws between a deal worth doing and one worth passing on.

Underwater owners are the most natural subject-to sellers alive, because a conventional sale would require them to show up at closing with cash they don’t have. Most investors either avoid them completely or take every one that calls. Neither is right.

Below: the underwriting math on two near-identical deals where one works and one doesn’t, the exact list criteria that produce negative-equity homeowners by design, how Steinhouse structures the transfer into a trust under Garn-St. Germain, and the two obligations that separate a legitimate operator from a predator.

From the Real Estate Pros Show

This article draws on an interview with Larry Steinhouse of Investor Schooling on the Real Estate Pros Show, hosted by Dylan Silver.

Why Underwater Owners Are the Natural Subject-To Seller

An owner who owes more than the house is worth has almost no conventional exit. Steinhouse walks through the arithmetic: a seller who is $10,000 underwater isn’t facing a $10,000 problem. Add agent commissions and closing costs and the real number to walk away from the closing table lands closer to $30,000, $35,000, maybe $40,000.

Most sellers in that position don’t have it. So they stay, or they stop paying. A subject-to buyer who says “it costs you nothing to sell your house, and I’ll pay the transfer tax on both sides” is the only real option on the table.

Steinhouse learned this out of necessity. He lost everything and went bankrupt in 2008, and was buying property again roughly a year later with no money at all. Subject-to was the mechanism.

One detail worth copying: who pays closing costs is a negotiating lever tied to how deep the hole is.

• Very over-leveraged seller: the seller pays the closing costs. You’re absorbing more negative equity, so you don’t also eat the costs.
• Close to break-even seller who has no cash: Steinhouse will cover closing costs himself to get the deal done.

That framing matters for the conversation too. You are not negotiating a price. You are solving a problem the seller cannot solve any other way, and the consideration you’re offering is the removal of a $35,000 liability.

The Underwriting Math: When a Monthly Deficit Is Actually a Down Payment

Run two numbers before anything else: the mortgage payment and the market rent. The spread between them decides the deal.

Steinhouse’s bad-deal example: house worth $300,000, mortgage balance $310,000, payment $2,500 a month, market rent $1,800. You’re $10,000 underwater on the balance sheet and $700 a month underwater on operations. There’s no path. Pass.

His acceptable example changes one variable. Same $2,500 payment, but the property rents for $2,300. Now you’re short $200 a month, or $2,400 a year. Compare that to what a conventional purchase of the same $300,000 rental would cost you at closing — roughly $60,000 down, at minimum.

At $2,400 a year, it takes a very long time to spend what the down payment would have cost you on day one. And every one of those payments is amortizing the loan. Hold it long enough and you own a $300,000 asset free and clear, having never written a down payment check.

That model assumes rents never rise and values never rise, which is deliberately conservative. The real timeline is shorter.

Two caveats Steinhouse is firm about:

• You have to be able to afford the deficit. A $200/month shortfall across six houses is $1,200 a month of personal cash flow. If that breaks you, the strategy breaks you.
• There’s a depth limit. In his words, he doesn’t say no to subject-to deals that are underwater — he says no to deals that are really underwater.

If you can’t identify where the money comes from, don’t do the deal.

You could ruin someone’s life by taking over their mortgage payments and not paying them. There are unethical people out there who actually teach, so what, who cares what happens if you don’t pay the mortgage, it doesn’t affect you, it affects the seller. As soon as those words come out of somebody’s mouth, you should turn around and walk out of the room.

— Larry Steinhouse, Investor Schooling

Finding These Sellers Before They Find You

Skip the foreclosure list. By the time a homeowner shows up there, you’re competing with everyone and the file is a mess. Steinhouse pulls a list that produces negative equity by construction.

The criteria, run through a data provider like ListSource:

• Purchased in the last three years
• Financed with an FHA loan
• Received seller assist (seller-paid concessions)

Think about what that combination means. The buyer put 3% to 3.5% down out of pocket and rolled the concessions into the price. They bought at $100,000 and effectively owe something like $105,000. Every name on that list is underwater. You’ve found the condition before anyone is in default.

Some share of those owners need to move — new job, bought another house, divorce, something. Those are your calls.

The mail piece matters as much as the list. Steinhouse’s letter leads with other people’s circumstances, not the recipient’s: in my business I come across people all the time who need to move — divorce, job change, and so on. I find a lot of them are underwater. If you’re underwater and you need to sell, I can help you get out without it costing you a cent.

That third-person construction does real work. It removes the accusation and, as Dylan Silver noted on the show, it briefly lifts the sense of isolation — the reader sees they’re one of many, not a uniquely failed case.

The response it generates is unusual. Steinhouse gets people calling in tears asking whether it’s real, whether it’s a scam. That’s the tell that the offer is landing on the right list.

Due-on-Sale, Trusts, and the Garn-St. Germain Angle

First, the terminology. What investors call the due-on-sale clause is technically the alienation clause. Knowing the correct name is worth something when you’re on the phone with a lender.

Steinhouse’s practice is to take title into a trust. Under the Garn-St. Germain Act of 1983, transferring a property into a trust — which most people do for estate planning — doesn’t trigger the lender’s right to call the loan, provided the beneficial interest stays the same. The rule doesn’t specify how much beneficial interest must remain. Some investors handle that by leaving the seller as a 1% owner, which Steinhouse considers unnecessary but harmless.

If a lender ever asks who the beneficiary is, his scripted answer as trustee is that he’s under orders from the trust not to disclose it, and they’d need a court order.

His practical read: no bank is going to pursue a court order over a loan that’s current. It isn’t worth the cost to chase a performing note. And if the loan isn’t current, the bank is calling the original borrower anyway — which is the whole reason payment discipline is non-negotiable.

On documents: an attorney-drafted trust typically runs $2,500 to $5,000. Steinhouse’s complaint about attorneys is that when they don’t understand a structure, the default answer is “you can’t do that,” because enumerating the risks is more work than refusing.

Treat all of this as one operator’s practice, not legal advice. Trust law, lender behavior, and enforcement vary by state and by loan. Have your own counsel review your structure before you close anything.

The Two Obligations That Keep the Deal Ethical

Subject-to has two duties attached that most training skips. Both belong to you, not the seller.

One: pay the mortgage, on time, every time. If you miss, it doesn’t damage you — it damages the seller whose name is still on the loan. Steinhouse is blunt that there are educators who shrug at this on stage, and his advice when you hear it is to walk out of the room. You can destroy someone’s credit for years. That’s the entire ethical weight of the strategy.

Two: handle the seller’s future financing. The common belief is that a seller who deeds subject-to can’t buy again. Not exactly. Steinhouse’s experience is that once you can document that someone else has been making the payments for six months to a year — the window varies by lender — underwriting will disregard the loan.

What this looks like in practice: two or three years after a deal, he gets a panicked call. The seller’s mortgage broker has flagged the old loan and is telling them they can’t qualify. Steinhouse asks the broker to call him, sends over the payment statements showing he’s been servicing the note, and tells them to put it in front of the underwriter. Three days later the broker calls back, surprised it worked, asking to learn more about subject-to.

Set that expectation at the kitchen table. A seller who wants to buy tomorrow probably can’t. One who can wait six months to a year usually can. Saying so upfront is what keeps you out of trouble later.

Running the Rentals You Acquire This Way

Subject-to deals are long holds by design — the math only pays off over years of amortization. That makes tenant performance the thing that determines whether you can carry a monthly deficit.

Steinhouse sets expectations with a script he delivers twice: once during the tenant interview, again when he hands over the keys.

• Rent is due on the 1st
• It’s late on the 2nd
• $150 late fee on the 5th
• Eviction is filed on the 15th

And the part that makes it stick: if you’re in a car accident, if you’re in the hospital, if your grandmother dies — call me, I’ll send flowers, and I’m still filing on the 15th. Do we understand each other?

He reports three evictions in 42 years. Not because he’s lenient, but because the rule was stated clearly before anyone moved in and was never ambiguous afterward.

The companion to that policy is his charity, LEV27. It exists for the tenant who was never habitually late, was living paycheck to paycheck, lost a job suddenly, and already has new work lined up but can’t bridge the gap. LEV27 will pay a month or two of rent plus the landlord’s legal fees, on two conditions: the tenant can demonstrate they can pay going forward, and the landlord agrees not to evict.

That’s a workable model for any operator. Enforce the lease without exception, and build a separate, documented mechanism for the genuine emergencies — rather than making case-by-case exceptions that erode the policy for everyone.

Frequently asked questions

Can you do a subject-to deal if the seller owes more than the house is worth?

Yes, and negative-equity owners are often the best candidates because they have no other exit. A seller $10,000 underwater would need roughly $30,000 to $40,000 in cash to close a conventional sale once commissions and closing costs are counted, so a buyer who takes over the loan and covers transfer tax is solving a problem nobody else can.

The constraint isn’t whether they’re underwater — it’s how far. Larry Steinhouse takes underwater deals routinely but passes on ones that are, in his phrasing, really underwater.

How much monthly negative cash flow is acceptable on a subject-to deal?

Compare the annual deficit to the down payment you would otherwise have written. On a $300,000 house, a $200/month shortfall is $2,400 a year against the roughly $60,000 you’d put down on a conventional rental purchase — and your payments are amortizing the loan the whole time. That math works.

A $700/month shortfall on the same house does not. There’s no mechanism that closes a gap that size, and you’re compounding it with negative equity. The other requirement is simple: you must actually be able to afford the deficit out of other income.

How do you find homeowners who are underwater on their mortgage?

Pull a list of homes purchased in the last three years with an FHA loan where the seller provided assist or concessions. That combination produces negative equity by construction — the buyer put down 3% to 3.5% and financed the concessions into the price, so they owe more than they paid.

Mail that list with a letter framed around other people’s circumstances rather than the recipient’s. Reference the divorces, job changes and relocations you see in your business, then offer to get them out without it costing a cent.

Will a bank call the loan due if you buy subject-to into a trust?

Steinhouse’s experience is that it almost never happens when the loan stays current. The Garn-St. Germain Act of 1983 provides that transferring a property into a trust doesn’t trigger the alienation clause as long as the beneficial interest stays the same, which is the structure he uses on every deal.

His practical argument is that a lender would need a court order to compel disclosure of the beneficiary, and no lender spends that money chasing a performing note. This is one investor’s practice, not legal advice — have your own attorney review your structure.

Can a seller buy another house after selling subject-to?

Usually yes, but not immediately. Lenders will generally disregard the old mortgage once you can document that someone else has been making the payments for six months to a year, depending on the lender.

When a seller’s mortgage broker flags the loan, Steinhouse sends over statements showing he’s been paying and asks the broker to put them in front of the underwriter. It typically resolves in a few days. Tell the seller this at the kitchen table so there’s no surprise two years out.

The bottom line

Before you mail a single letter, decide what monthly deficit you can personally carry across every deal you intend to do — that number, not the seller’s story, is what tells you which underwater houses you can buy and which ones you have to walk away from.