Why Sub2 Deals Are Riskier Than You Think

 In this episode, Jaden and James break down the real risks behind Subject-To, also known as Sub2, real estate deals. 

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Sub2 investing is often marketed online as a creative financing strategy, but the hosts explain why it can create serious legal, ethical, and financial problems for sellers and investors. They discuss how these deals work, why they may violate due-on-sale clauses, and how sellers can be left exposed if the buyer defaults or the bank calls the loan due. 

Jaden and James also share their concerns about influencers teaching complex strategies like Sub2 to inexperienced investors without fully explaining the risks. From damaged credit to foreclosure and lawsuits, they explain why these deals can quickly become dangerous when handled incorrectly. 

The hosts also compare Sub2 with other forms of creative financing, including seller financing and lease options. They explain why traditional seller financing can be a cleaner, more ethical win-win when the seller owns the property free and clear, and why lease options may offer a lower-risk alternative in certain situations. 

With more than 20 years of experience, Jaden and James explain why they rarely use Sub2 themselves and only consider it when they have enough cash reserves to pay off the loan if needed. Their message is clear: building a portfolio on risky Sub2 deals can create a shaky foundation that may collapse when banks, sellers, or life circumstances change. 

Watch this episode before jumping into Subject-To investing. 

Topics Covered: 

•  What Subject-To real estate deals are 
•  Why Sub2 deals can be risky for sellers 
•  Due-on-sale clause concerns 
•  Ethical concerns with creative financing 
•  Seller financing vs. Sub2 
•  Lease options as an alternative 
•  Why influencers may be underplaying the risks 
•  Lawsuit and foreclosure risks 
•  How experienced investors manage risk 

Disclaimer: This video is for educational purposes only and is not legal, financial, or investment advice. Always consult with a qualified attorney, lender, and financial professional before entering into any real estate transaction.
 

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Transcript

SPEAKER_01 0:00

We got a question about creative finance deals.

SPEAKER_00 0:02

Do you get a lot of seller finance? Have you heard of sub two? Anytime anyone even says the word creative financing, I'm like, shut the f up.

SPEAKER_03 0:08

The sub two is borderline unethical. You have all these influencers teaching really young people how to do this stuff and not really explaining to them the ethics of it, the legalities of it, the dangers and risks of it, and how you could really destroy somebody else's life if you're not careful. The bank won't do anything about it because banks are lazy. All right, welcome back to the JJ James Real Estate podcast where we talk about real estate and whatever else comes up. James, how's it going?

SPEAKER_04 0:35

Still going.

SPEAKER_03 0:36

Alright, let's uh let's jump into it.

SPEAKER_01 0:43

We got a question about creative finance deals. Do you get a lot of seller finance? Have you heard of sub two? What do you think about any non-conventional way?

SPEAKER_00 0:52

I don't like any of it. I honestly anytime anyone even says the word creative financing, I'm like, shut the f up, get out of my get out of here.

SPEAKER_01 0:59

Doesn't it make sense if that's the thing that can push a deal through? For example, if someone buys a house three, four years ago and they got a two and a half percent interest rate and now rates are five and a half, six percent, doesn't it make sense to try to just sell or finance the equity that's there or you can't pay someone money to be able to take over the loan?

SPEAKER_00 1:17

You can't do it. There's no way to to there's really no great way to keep a loan and transfer an asset. I trust me, I would do it if I could. I have been in this business for I I What's this guy's name already?

SPEAKER_03 1:33

Or do we have this guy? I don't know who this guy is.

SPEAKER_04 1:39

I don't think I've seen him before. I have not seen him before. I thought it was somebody else.

SPEAKER_03 1:43

I kind of like what he's saying so far. It's not Mr. Clean.

SPEAKER_04 1:54

It should be in the notes on the bottom.

SPEAKER_03 1:57

It should be up in the notes, shouldn't it? Who this is? Ice coffee hour. Who's below the ice coffee hour there? Jack. No, it's not Jack. Jack and Graham. Okay. That's not that those are the other two guys. We probably should know who the guy is before we start. I don't know.

SPEAKER_02 2:24

I have no idea. Okay. Um You think they would put it right here somewhere.

SPEAKER_03 2:31

Yeah, that's weird. Okay, I guess it doesn't matter. I just I'm really curious as to who he is. Okay, let's get back to just talking about it then.

SPEAKER_02 2:38

Does any of these videos have his name on it?

SPEAKER_04 2:41

Okay, he was just saying something, and I I thought you were gonna jump on it, and then I then I didn't.

SPEAKER_03 2:46

So I'm not you can you can if you want to talk about it, go for it.

SPEAKER_04 2:49

Yeah, I'm just saying that I agree with him a little bit on that. Um, you know, Pace Moby. He's unless you're a very high-end financial person and understands numbers, he's teaching this shit to 18-year-olds, 19-year-olds that you know they think they're gonna get rich fast, and then they're telling the homeowners they're screwing people up. You know, there's a lot of I'm waiting for all the lawsuits to come out because of it. Um, now I will tell you we have a couple of them that are sub two, but you and I own them, so we know that we can take it to the market or pay off uh uh the loan if it gets called, but other than that, I was gonna say, I think we we probably 90% agree with what this guy is saying.

SPEAKER_03 3:34

Well, he's saying all creative finance, so that's where I have a problem with him. Like there's there's creative finance and then there's sub two, which is a little part of creative financing, but there's when you say creative finance, let's there's a whole world of that where 90% of creative financing is not sub two. But he's kind of saying they're the same thing, I think. And creative finance is really a great thing. Um, the sub two part of it, I mostly agree with what he's saying. That sub two is I mean, it's is it straight up illegal? Not quite straight up illegal, but it's very close.

SPEAKER_04 4:09

Um it's borderline ethical.

SPEAKER_03 4:12

It's very close to being illegal, it's it's borderline unethical. Um, so you've got to be really careful. It is so many. I almost feel like sub two is almost like what wholesaling was 10 years ago. You have all these influencers teaching really young people how to do this stuff and not really explaining to them the ethics of it, the legalities of it, the dangers and risks of it, and how you could really destroy somebody else's life if you're not careful. It's like, well, we can make a lot of money doing this though. Well, sure, but you can also destroy a lot of people's lives doing it if you don't know what you're doing. You know, and sub two is really dangerous. So if you have if you're really seasoned um in real estate and you have capital and you have backing and you can stand behind a deal, then I think sub two can be okay.

SPEAKER_04 4:59

We've done some sub two deals, and we've I don't think you're gonna do sub two then, Jaden. I think the educated person is gonna figure out another another element. Well, we've done a couple of them.

SPEAKER_03 5:07

I mean, we've done sub two deals. We're gonna do one right now. We're doing one right now, actually. That makes a lot of sense to do. But the the difference is here's the difference. If you're gonna do a sub two deal, what you're essentially saying is the person that owns the house and has the mortgage is gonna transfer the deed to the house to you or your company, but the mortgage is gonna stay in their name. Because if the if the mortgage doesn't stay in their name, it needs to get paid off, and then there's no value to that really good mortgage, the mortgage is gone. So it has to stay in their name. So why would a person transfer a house to you and keep the debt in their name? Well, mostly because they're going to foreclosure and they're gonna have their credit destroyed if they don't do something like that. That's mostly why why it would happen, and that's this deal that we're doing right now is that that is the kind of the situation that it's in. But we are very careful to explain to these people exactly how this works, exactly how it affects them, what the risks are. Also, the bank, the bank can call their loan due. There's a risk of the bank saying, Hey, we noticed you transfer the deed to somebody else. Uh our mortgage says if you do that, you've got to pay the mortgage off. So go ahead and pay the mortgage off. You got you know 12 days to pay us, $300,000.

unknown 6:20

Right.

SPEAKER_03 6:20

And again, this is the original owner that gets this letter, not the people that own the house. So that then they get, you know, they don't have $300,000 to pay the mortgage off. So then they're then they're gonna be going to foreclosure because they you know they're in default essentially. So we as the sub tube buyer have to be in a position where we can quickly come up with the cash to pay that mortgage off if something happens. And that's why we we will only do deals like that where we know if something happens, we can buy this thing out really quickly and get the whole thing gone. We also have to be comfortable with the purchase price of the house being at a point where if we have to go buy the whole thing out, it still makes sense for us to do this, right? Because a lot of these deals are like, oh, the house is worth $300, there's a 3% mortgage at $295 or $305 or whatever. But since the mortgage is so cheap, it's a good deal, right? So you should go buy the sub two with a $300,000 mortgage for a house that's worth $300,000 that needs $20,000 to work, too. And you should just buy the house and take the mortgage over. Well, what if in two months something happens and you have to pay that mortgage off for $305,000 or whatever? You're gonna lose a bunch of money on that deal, you know. And this happens. This happens. So you can get there could be a lawsuit with the original seller, the bank could get a lawsuit, the bank could foreclose. These are really hairy deals. And um, it it does frustrate me how you know Pace Pace is a really smart guy, and he has the sub two thing with the you know, that whatever. It frustrates me how casual he is about all this stuff. And it feels exactly like 10 years ago when people were teaching about lying about lying about assigning contracts. Here's how you get a contract on a house, here's how you lie about it, here's how you wholesale it and make money, and then you know, and then just train a bunch of young people on how to do this unethical stuff. And I feel like the sub-2 thing is real similar to that. And uh it's a it's like a way to make money, but like you gotta be really careful. I don't I don't want to go through life and cause a lot of damage to other people. Like, who wants to do that? That's that catches up to you, man.

SPEAKER_02 8:32

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SPEAKER_03 9:01

What goes around comes around. And if you start messing people's lives up, it's it's not worth any amount of money if you're causing damage to somebody else's life through the stuff that you're doing. And this to do the sub two stuff properly, I mean, like, look at us. We've been, I mean, I've been doing real estate for over 20 years, and we will barely do this stuff, so that should tell you something how dangerous it is.

SPEAKER_04 9:25

But well, I was just gonna give an example, Jaden, of uh one of the sub twos that we actually had and uh how we approached it because you know I know I don't know what the threshold that Pace teaches, but some of these guys teach, hey, if it has any kind of cash flow, great, take it. And and yeah, what I mean from fifty dollars to a hundred dollars, you know, it's not negative, even even negative equity, they'll take negative equity as long as the cash flows, right? So what we did it was a townhouse that uh we got sub to, and we contract for Did back out, and so we gave the lady $20,000 or what was it? It was for a $160 mortgage. I think we gave her $10,000, and we got the $10,000 back because we took a 40k down payment, and I out can you hear me?

SPEAKER_03 10:28

You're back now.

SPEAKER_04 10:29

Oh, what are where did you lose me at?

SPEAKER_03 10:31

10k down payment.

SPEAKER_04 10:33

Okay, so a 10k down payment. Um, that's how we bought it, and then we fixed some of it up and then put a family in there, asked for 40k down, and our mortgage on this, the sub two, is $550 a month, and we collect $17.85 on it.

SPEAKER_03 10:54

Yeah, and that's a hell of a we're there's there's enough financial room in that deal where there's enough equity in it, there's enough cash flow in it, that if something goes sideways with the original sub two mortgage, we will step in and take the mortgage out and pay it off. Yep, and we will go pay it off cash, or we'll go get a bank loan or whatever we're gonna do to take that out because it's worth it for us financially to do to take that risk.

SPEAKER_04 11:19

But when you start hearing I want to hear what this guy has to say because I think, like you said, uh we've already been mumbling a lot.

SPEAKER_03 11:26

Well, I wanted to say one more thing because like I wanted to say creative financing that's not sub to is actually really good, and like if you get someone to sell or finance the house to you, it's usually really good for the seller, and it's really good for the buyer, and it's it can be completely ethical. Like it's the kind of deal like is a win-win-win deal all the way around. So I hate that this guy is saying creative finance, no. That is whole that's really, really wrong. Creative finance is not.

SPEAKER_04 11:55

Well, because sometimes you have to. You have to think outside the box. Hey, wait a give the thumbs up.

SPEAKER_03 11:59

You don't have to. I mean, if if somebody owns a house free and clear that's worth 300 grand and they don't need the money, because they're you know, they're say they're retired, maybe they want an income stream, they don't want all the money right away. Give them a down payment and and pay them a monthly payment on a mortgage that they they hold the mortgage. That's gonna be amazingly good for them, and amazingly good for you. So it's yeah, that's those are awesome deals. Um, anyway, go ahead and play the rest of this.

SPEAKER_00 12:24

You know, 15 years, done billions of dollars in deals, not a single deal.

SPEAKER_01 12:29

A single deal have I been able to have the original loan kept. So we've spoke to this guy Pace Morby, and this is like his whole big thing. He's got like a couple thousand units or something. He talks about it, he's like the guy on YouTube that talks about creative financing, specifically also Stub 2, which is basically you go in, you take over the mortgage payment, so you just spend the money. And then I think what he does is he puts the deed in a trust or something. Uh and it doesn't count for a sale. And then, you know, you have the do-on sale clause of the of the loan. Yeah, that's when it's which like it's only ever he's only ever been called on once out of its thousands of deals that he's done for this.

SPEAKER_00 13:10

But doesn't he remain liable for the asset, liable for insurance, liable and litigation? So you're saying it's the owner is the owner. How is that any different? How is that really substantively any different than a lease with an option to buy? It's it's similar, yeah. Yeah, I mean that's not a transfer of an asset. I'm not saying it's dumb. You know, I think a lease option can make sense, but it's just I I my understanding is that he would still be liable for anything and everything. Maybe in commercial real estate, you know, you can that was one of the things that we said.

SPEAKER_04 13:49

You're still made a transaction, you're still liable to make the payments, but unfortunately what you said, Jaden, is now you're bringing in uh you could destroy somebody else's life, their financial life. Because you didn't pay something.

SPEAKER_03 14:05

So there's a lot of things here. There's there's the ethics, there's you know how you treat people, there's the law, what the law says. And the thing is, is like even if you do everything legally, which I'm sure Pace does, because he's you know got probably good lawyers and stuff, at least in Minnesota, if somebody feels like things didn't go well for them in a transaction, they will sue you. And I'm sure that's true in other states too. And it doesn't matter whether you did anything wrong or not, you're still gonna get sued. And if you get sued, you've got to go pay for attorneys and show up in court and deal with lawsuits. And I I hear like, you know, pace I always think about scalability of business systems. He has a thousand units or a two thousand units, I'm like maybe he's got this figured out too, but I'm just like, how many lawsuits is he is he in all the time? You know, I just sit there and think, like, if you got a thousand units on sub twos, like, how often are you getting sued? You know, over something? Probably a lot. I mean, the few sub deals, sub two deals we've done, like a handful, like I think our our our hit rate on something going wrong on them is like 25%. So and it's usually like we we've gotten attorneys involved, we've driven like been very transparent about everything and communicated everything and documented everything, but something changes in a seller's life two years later, and they no longer want this mortgage attached to them. But all the documents say that they agreed to that this mortgage would keep being attached to them. Yep, but they don't like it anymore. Well, at the end of the day, the fact that they don't like it anymore is a problem, you know. Even if you covered your bases and did everything right, it's still gonna be a problem for you, right? So, and that we've found that to be true, and that's why we're we're really we shy away from them. But he mentioned lease options, which I think is really interesting. A lease option is probably the cleaner way to do this kind of deal with somebody, and without all this hair of a sub two deal.

SPEAKER_04 16:09

Because if you do it, but doesn't that trigger the duan clause, though?

SPEAKER_03 16:12

Because again, remember, I mean lease option, an option to buy is not actually buying. So the like the mortgage says if you sell the property, you have to pay the mortgage off. Well, if you do an option to sell the property, that's not selling the property, you know. So also the options don't have to be recorded anywhere, like you just have a private option contract with somebody, at least it's not a good thing.

SPEAKER_04 16:34

Because you're not really selling, you have the option to sell it as well.

SPEAKER_03 16:37

It's an option to sell the it's an option to sell at a at a fixed price. And I've thought about this for years. Like, that is a pretty clean way to do it, I think. We we haven't we've never done that. Um, but I've certainly thought about that. Like, that seems like a cleaner way to do it that you're not this property's not being sold, so there's no trigger of the mortgage. But one problem with that lease option, I think why people don't like to do it is that the original seller still holds the deed. So the the problem is say five years down the road, you go, Okay, I want to I want to buy out a I want to sell my interest in that property now. Well, you don't have the deed, so you're gonna exercise your option to get the deed. What if the seller died or moved or won't talk to you and won't cooperate? Like they can prevent you from getting the deed because they have it. And so you don't really have total control over the situation in in that kind of a transaction, and that's definitely a risk. So that's probably why people don't do that that often.

SPEAKER_04 17:36

Let's see what else he has to say, because I again I think he's 100% what we think.

SPEAKER_00 17:40

Yeah. And isolate that risk a little bit, and maybe it's a little bit different, but in residential real estate, there's really no great way to do it.

SPEAKER_01 17:48

So you're saying the seller in this instance, if you are selling a house sub two to someone else, so sub two is like when you just take over the payments, basically, then as the seller, you're still liable for anything that could go wrong with that.

SPEAKER_00 18:00

Yeah, because you probably created some type of joint venture or trust or whatever it is. So his also the other thing too is um you have to remain the sole owner. If there's any other ownership, then the bank can call the loan.

SPEAKER_01 18:12

But he's he's been called by the bank once, but he said most of the time the bank just want to ignore it because this is just one small thing that's been sold off and sold off and sold off. And I'm not in actuality, I'm not gonna risk my loan. As long as they're performing, then that's all that matters. I agree that you're right. And there's also, I will say, there's a is it there's added benefit to the seller that that we haven't even considered.

SPEAKER_04 18:37

He he seemed annoyed, you know. He gets it.

SPEAKER_03 18:40

Well, I think what you what you're seeing is that this guy is he's uh probably you know a pretty astute business person and he understands risk and understands managing risk, and he doesn't like taking you know extra risks that are not necessary, you know. Right. And I think that's if you look at this guy versus Pace Morby, Pace Morby is I mean, if if you watch the stuff, it's like I mean, risk. He doesn't even I don't know if he even cares about risk or understands.

SPEAKER_04 19:08

I don't know if he talks about that much, yeah.

SPEAKER_03 19:10

It's irrelevant to him, the risk. So, because if you look at what he's doing, like there is a risk of his entire portfolio disappearing. You know, if something changes with banks or how they deal with these, if they actually do decide to start dealing, because he's operating in a very gray area, so but he's obviously okay with the risk he's taking. This guy is sitting there going like, well, I don't want to build a thousand unit portfolio that is sitting here with a structural risk at the base of it that could be pulled out and removed from me whenever they want to. I mean, I would say not. So, but pace obviously has a high risk tolerance. The other thing that comes to mind is Arnold Schwarzenegger has these motivational speeches and he talks about uh break the rules. You should break the rules. Break the rules, you know, break the to be successful, break break some of the rules, he says. Don't follow all the rules. And I feel like you know, so I think what Pace Morby is doing is he's breaking some of the rules, and I it's not necessarily all bad, um, but you just need to understand.

SPEAKER_04 20:16

Breaking or bending.

SPEAKER_03 20:18

Well, he's I would say he's breaking the rules.

SPEAKER_04 20:21

I think so. Because I I I because I hear breaking the rules is is it's kind of like it's illegal, you can't do this, but obviously he is, so that's why I say bending the rules because he is he's bending the rules, no, the rules read the mortgage.

SPEAKER_03 20:35

The the mortgage says if this house sells and the deed transfers, the mortgage has to be paid off, right? They are transferring the deed and not paying the mortgage off. So, by the definition of how the mortgage is written, they are breaking the rules. They're just counting on the fact that the bank doesn't want to do anything about it. So they are breaking the rules. They're just gonna, well, the bank probably won't do anything about it. And for the most part, I think that's been true. The bank won't do anything about it because the banks are lazy. And if you're paying the payment, why would they? Oh, we're collecting money. It's gonna it's expensive for banks to foreclose on properties. Why would they want to do that? You know, so it's not that he's not breaking the rules, is that he's just figured that the rule is worth breaking and the banks usually won't do anything about it.

unknown 21:15

Yep.

SPEAKER_03 21:16

And I think so far that's been true. Totally.

SPEAKER_02 21:21

Go ahead, Brady. After some quick research, I believe this guy's name is Jason Oppenheim. He's allegedly selling sunset related. I don't know if he's on it or a producer of it or what his role is, but that's where he comes from, I guess.

SPEAKER_03 21:38

Oh, he's like a realtor that sells uh beach properties?

SPEAKER_02 21:43

Allegedly. Allegedly.

SPEAKER_03 21:46

I don't know what what uh authority he would have to even speak on the subject then. So anyway, let's go ahead and go.

SPEAKER_01 21:54

Which is you know, if you're selling a house at a two and a half percent interest rate, basically, when you take over the loan. Then the person can overpay whoever's buying the house. Or what you also say.

SPEAKER_00 22:05

Wait, let me ask you a question. Let you you you're you're I I own a $10 million house, right? I have let's say I have $5 million of equity and I have a $5 million loan at 2.5%. And I structure this. Does this guy give me cash? Oh you can yeah, yeah. Oh wait, 100%. It'd be similar to at least option. But that but that cash up front is going to be treated as as income. Whereas on sale, it's treated as long-term capital gains. So now I'm paying 50% tax on the on the money that he gives me when I could be paying 28% tax. Or what you could do is just increase the sale price of the home, right?

unknown 22:41

No.

SPEAKER_00 22:41

Just go ahead and stop it. How's that solved?

SPEAKER_03 22:43

Well, you could I see what he's trying to do. Yeah. They asked, you know, is he is he paying me cash for that, you know, the five million dollars of equity? Like, no, that's not happening. That's not how these the whole point of these deals is that people are not putting any cash into these deals. That's the whole allure of sub two is that they're like no cash deals or low cash deals. So no, he's not no one's giving you five million dollars cash for your sub two deal. That is ridiculous.

SPEAKER_04 23:07

Well, well, first of all, they could if it's if we're gonna keep it super low, but if you already have millions of dollars like that, you don't need you don't need to do a sub two having them carry four.

SPEAKER_03 23:17

What I'm saying is he could get a higher price by doing sub two or create in his case. If he wanted to get a higher price for it, he would have to sell or finance that five million dollars of equity to somebody else. And go, you can come in here with a really low down payment, I'll carry back the five four and a half million or whatever, it's called a seller carry back loan at five percent interest or whatever, and then that's a pretty good deal for someone to come into with a low down payment, and that's what would make his property more valuable. This guy doesn't sound like he even really understands the how this works, but I do agree with him that they're very dangerous deals, and Pace Worby does not treat them with quite the again. My opinion, he's doing it successfully. Obviously, people can do it. I just want to build a business, I want it to be very solid on a solid foundation. So that's my and I don't want to have risk of uh harming people in the process of of the business running, you know. So anyway, I think we've we covered that one pretty good, I think. Brady, if you want to wrap it up here, James, you want to wrap it up?

SPEAKER_04 24:18

Yeah. Um, hey guys, if uh you like what you've been hearing, uh you want to follow us, uh click the link below. You know, guys, make a comment. Uh, whether you like us, whether you don't like us, we don't care, we just want to comment. Um, preferably you like us. But uh there's anything else at um anything with uh with Home Guys itself. If you guys want to schedule a consultation with Jaden or myself, again, click the link below and uh we'll talk. So um hey guys, uh just remember we made all the mistakes so you don't have to. Have a good one.