Creative Financing and Uncreative Insurance Options

By Derek Kartchner | Gila Insurance

Creative real estate investing has the potential to create massive rewards. However, anyone who has taken a finance class knows there is often a risk vs reward trade-off –the higher the risk, the greater the reward. (A caveat: I am neither pro nor anti “subject to,” “wraps,” or any other creative investing/financing scenarios. I simply want to point out a couple of risks when it comes to the insurance side and some POTENTIAL problems and solutions). 

“Subject To” Clauses: Simply Defined

When purchasing a property “Subject To,” the buyer takes over the existing mortgage payments while the loan remains in the seller's name. The how and why etc. can be left to the experts, but if you are considering this investment vehicle, there are some things you should consider.

The Insurance Problem: Insurable Interest

One of the key issues in a “Subject To” deal is insurance coverage. The buyer, now responsible for the property, needs insurance to protect their financial interest. However, the concept of insurable interest complicates this.

In most cases, an insurance company will only issue a policy to someone with a clear legal interest in the property. Since the buyer doesn’t hold the mortgage in their name, convincing an insurer to issue a policy directly to them can be tricky.

The lender's insurance policy requirement is typically tied to the seller, leaving the buyer vulnerable to one of two unpleasant outcomes. The first is accidentally triggering the Due-On-clause (in short, the seller sold the home; they now need to pay off the mortgage). The second is that you don’t trigger that clause but have a claim and can’t get paid. 

Navigating These Risks - Potential Problems and Their Pitfalls:

Insurance companies do not contemplate the issue of a ‘Subject To” clause popping up, so it is still an ambiguous gray area.

I have had in-depth conversations with investors about this. I have my opinion, but others may have a different point of view. I have laid out a few ideas, however I don’t believe there to be a clear-cut solution.

Buy a Separate Policy: So, this is possible. Many people have issues with it because it increases costs. It also would trigger the “Other Insurance” clause of the insurance policy. 

When there are two policies on the same property, each company should pay on a prorated basis. However: 

1. This could cause problems in the event of a claim and could trigger the due-on-sale clause. 

2. By not notifying the insurance company of your other policy, you would violate the terms of the policy. 

Leave the Policy in the Name of the Seller: The problem here lies in the fact that when there is a claim, the check will be written in the name of the seller. You now are reliant upon the seller to work with you in signing over the check and forking over the money. Some may say that the limited Power of Attorney should solve that. I have discussed this issue with several investors for whom the POA did not work as the bank rejected it (I don’t know why).

Add Yourself as an Additional Insured: Again, the seller's name will still be required to cash the check. 

Transfer the Ownership to a Trust: Trusts have their own issues, but it can possibly solve the issue of getting paid in a Claims scenario as Trusts are normal and natural things that banks can see regularly. This still can create scrutiny AND trigger the due on sale clause.

In summary, buying a property "Subject To" can offer attractive benefits, such as avoiding the need for new financing. However, it requires careful attention to insurance and the Due-On-Sale clause. Not all insurance carriers will entertain a Subject To property, so my recommendation is to work with your insurance agent and be upfront about what you are doing. Do your due diligence to make sure that you have a plan in place to not only get the property, but to protect your investment as well.