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Substitution of Collateral is an incredibly powerful strategy for building wealth when you’re buying a home and your seller is the bank. We love the idea of owner-financing, or “seller carrybacks” in real estate investing. You want to ensure that this very important strategy is included in your purchase side paperwork.
So, what does Substitution of Collateral mean?
Substitution of Collateral has many names. The most common moniker that we hear is “Walking the Mortgage”, but others include “Substitution of Security” and “Portable Mortgage”. All of these terms mean the same thing, but the best way to describe what happens in a Substitution of Collateral scenario is to provide an example.
Substitution is nothing more than moving a mortgage (lien) from one property to another. Let’s say that you purchased a property that was financed by your seller. You have given the seller a mortgage on the property for, say $100,000. You have been diligently making payments to that seller and, in a few years’ time, you have that mortgage balance paid down to $50,000.
Now, let’s say that you have found a great deal on another property for $100,000. You’re excited because you know that this property will cash flow at a high rate of return for a very long time. The problem is that you don’t have the cash or financing in place to buy this deal.Here is where your creative mind takes over and instead of telling yourself that you can’t buy the new property, you ask yourself “How can I buy this property?”.
This is the solution you come up with:
You know that in the mortgage that you have on your seller financed deal, is a clause that allows you to substitute collateral, or subsitute what secures that mortgage. The clause allows you, with the consent of the mortgagee (the seller), to “walk” that mortgage to another property upon the sale of the original property that the seller owner-financed for you. So, let’s say that you have a buyer for the original property at $120,000. We know that you have a $50,000 balance on the mortgage with the seller. You’re now lined up for a $70,000 cash payday upon the sale of the original property. Now what you’re able to do is put a contract on the new property, offer to “walk” the $50,000 that your seller would have received upon the sale of the original property to the new property. You then fund the remaining $50,000 purchase price of the new property with the cash from the sale of the original property and you’re left with $20,000 cash in your pocket.
If your mortgagee (your original seller) doesn’t like this idea, you now have some cash that you can offer to incentivize your new “lender”.
What’s in it for your new lender?
If you can walk the mortgage to another property of higher value, the seller feels safer because they have higher value collateral. By moving the mortgage you bought from the seller to another property with a substantially greater value than the loan balance, it allows you to then sell that original property you bought and wind up with a lot of cash in hand.
You will need to ensure that the mortgage and the note with your lender is updated with the information on the new property.
One last thing, the substituted property does not necessarily have to be real estate. You can agree to use a car or boat title as the substitute collateral as well. Get as creative as you want.
Be sure to add this extremely powerful tool to your toolbox TODAY!