Mortgage subordination is one of the most common terms you will find in the real estate world. You can commonly find this word when you are trying to refinance your home. As you probably already know, refinancing your home will require a fair share of paperwork. And all of the terms in the whole process can be very intimidating.
If you are financing your home with a line of credit or home equity loan, you will come face to face with a subordination agreement. While that term sounds pretty daunting, it is a normal part of refinancing your home. That is why you need to know everything there is to know about this document.
A subordination agreement is a contract stating that you will prioritize a debt over another when you are repaying your mortgage. In this agreement, you will find statements that establish the superiority of one party’s claim to another party’s interest.
You will find subordination agreements happening all the time in any mortgage refinancing transaction. As an easy example, you might have two mortgages when you are financing your current home. And you might want to refinance your primary mortgage for certain reasons such as lowering the interest. The second mortgage lender might need to make a subordination agreement to give to the refinancing lender in the process.
A subordination agreement will adjust the priority of the new and old second mortgages. That way, the refinancing lender will stay on top of the priority when it comes to getting their debt paid in the event of a foreclosure.
To help you learn more about the subordination of real estate, we are going to tell you everything there is to know about this document. Keep reading this article and you will understand what a subordination agreement is and how it can be useful in the process of refinancing your home.
Mortgage Liens and How They Work
Before you learn more about the subordination agreement, you need to know about mortgage liens and how they work. Say you are taking a loan to buy a property. You will need to sign a deed of trust or a mortgage to secure your debt to the lender. The lender will then record your deed of trust as the first mortgage, creating a lien on your home.
After taking the first mortgage, you might need to take out another loan to finance your property. You might take a home equity loan, home equity line of credit or additional mortgage to finance your home. The leader of that second mortgage will also record the mortgage and get a lien on your property. You can call the second mortgage the subordinate mortgage or lien.
Now that you have two mortgages, you will also have to rank them in order. You can call the ranking order of the mortgages the priority. The priority of the lien will determine the repayment order in the event of a foreclosure sale. And the concept of priority is quite simple.
Mortgage liens will follow the “first time in, first right in” rule. The rule says that whoever records the lien of the property first, they have a higher priority than whoever records other liens later. So, you can determine the priority of these liens based on the recording dates, which is why you will find subordination.
A first mortgage will always be prioritized over a subordinate second mortgage. If a foreclosure sale happens, the first lien will have a right to get paid first. The second lien will be paid once the first lien is already paid and so forth.
While the “first time in, first right in” rule applies generally, you will find certain exceptions. Property tax liens will have automatic priority over every other lien, even if the property tax lien appears after another lien. However, judgment liens do not get priority over other liens recorded previously.
After a foreclosure sale, you might find a limited amount of money available. That is why low-priority liens or subordinate liens might not get any money after the foreclosure sale. And that is why subordination agreements are very important.
What is Subordination?
Now that you know everything there is to know about mortgage liens, let’s talk about subordination agreements. So, a subordination agreement will help you rank the home loans that you use to finance your property. These home loans might include a mortgage, a home equity loan, or a line of credit. Through a subordination agreement, the lenders will assign a lien priority to the loans. And as we have mentioned before, the priority depends on whoever records the lien first.
You might be wondering what the importance of subordination is. Well, the most important role of the subordination agreement is to establish the lien positions of the mortgages or other home loans you might have. That way, the mortgages will be paid off based on the lien positions in the event of a foreclosure.
The first lien will always be paid first after a foreclosure sale. And the second lien will not see any money until the first lien is paid off in full. The same thing applies to the third, fourth, and other liens that might be involved in the process.
If there is not enough equity to cover your debt for the second lien, the second lien will lose money. So, a subordination agreement will not help you magically pay off all of your loans. However, it will help the lenders when it comes to estimating risks. That way, they will be able to set an appropriate interest rate for your loan. And that is essentially the importance of a subordination clause.
Will Subordination Affect the Refinancing Process?
Another thing you might be wondering is whether or not subordination will affect the refinancing process. As you probably already know, refinancing is where you pay off your old mortgage by replacing it with a better one. You might want to replace your old mortgage because the new mortgage offers better interest rates.
When you have paid off your old mortgage, the second lien in the process will automatically become the first lien. The second lien will become the priority while your new mortgage will take place as the second lien. However, most mortgage lenders do not like having the risk of being a second lien. That is why your new mortgage will most likely ask for a subordination agreement, assigning them as the first lien to your property. After recording the subordination agreement, your new mortgage will become the first lien while your previously second lien will become the subordinate lien once again.
When to Make a Subordination Agreement
So, you might be asking when it is appropriate to make a subordination agreement. You will commonly find subordination agreements in any mortgage refinancing deal. To make it easier for you to understand, we are going to give a simple example.
Let’s say that you want to refinance your first mortgage of $300,000 to get a lower interest rate on your mortgage. You also have a line of credit on your property for $75,000, which is the subordinate mortgage in this situation. You have a property that is worth $400,000.
When you refinance your first mortgage, you will pay the debt off with the new loan. The first mortgage lender will then release its lien on your property. After that, you will record the refinance loan, and the second mortgage (your line of credit), will automatically become the first lien since it is the oldest mortgage recorded on your property.
However, the refinancing lender that paid off the $300,000 mortgage will most likely require it to be the first lien. Refinancing lenders will usually require that before they agree to refinance your property, considering the risks associated with becoming a second lien. So, the refinancing lender will ask the line of credit to make a subordination agreement. The line of credit will agree if the home has enough equity to cover both debts in the event of a foreclosure.
After the line of credit signs the subordination agreement mortgage, the line of credit will give up its lien priority. The line of credit will then remain in the second position of the priority while the new mortgage gets the priority. And that is how a subordination agreement works.
Who Will Benefit from a Subordination Agreement?
Another thing you need to know about loan subordination is who will benefit most from it. The most obvious answer is the new mortgage lender will certainly benefit from the creation of a subordination agreement. This happens because the new mortgage lender will be the priority over any other mortgages that will be subordinated.
Because other lien holders will not gain any benefit from a subordination agreement, they might not automatically agree to make a subordination agreement. And if the existing lien holders will not give in to the request, the new mortgage lender might not decide to refinance the first mortgage, which can be a problem.
However, most subordinate lien holders will agree to sign a subordination in one condition. And that condition is if the home equity can cover all of the loans associated with the property. Therefore, you can see that a subordination agreement is quite common in the lending industry of real estate.
Who Will Execute a Mortgage Subordination Agreement?
Because the new mortgage lender will gain the benefit of a subordination agreement, this party will prepare the agreement. After the document is ready, all of the parties involved will typically sign the subordination agreement. However, the subordinating lender might be the only one to sign the paperwork in some cases of a subordination event.
Getting Help with Subordinate Financing
If you want to refinance your first mortgage on your property, the refinancing lender will typically handle all of the processes to get a subordination agreement. However, you have to make sure that the subordination agreement is ready before the closing date of the new loan. And that might be a very confusing process, especially if you know nothing about subordinations.
In some cases, the second lien holder does not sign the agreement in time. In those cases, you might want to hire a real estate attorney that will help you through the whole process. You can also contact a foreclosure attorney if you have any questions about lien priority in the event of a foreclosure. That way, you can understand subordinate financing a little bit better.
What Can You Expect When Making a Subordination Agreement?
After learning almost everything there is to know about a subordination agreement, you still need to learn so much. You need to learn things that seem trivial such as how long does it take to get a loan subordinated. Other than that, you should also know what you can expect in the process of making a subordination agreement.
You will be glad to know that the process of making a subordination agreement is usually seamless. You might not even realize that the process is happening until they ask for your signature. However, the process might face delays or require you to pay additional fees that might take you by surprise.
In the whole process, you should expect the lender to prepare the subordination agreements. You should also know that certain financial institutions will charge a subordination fee or any other fee like appraisal fees. On top of that, the process of making a subordination agreement can face a delay, especially if you are working with two lenders.
While all of the parties involved are dealing with a subordination agreement, you might see that your home equity loan is frozen temporarily. However, this will stop once the subordination agreement is complete. Those are some of the things you can expect during the making of a subordination agreement.
Final Thoughts
A subordination agreement might be one of the most important documents you will come across when you are refinancing your home. After learning all there is to know about the subordination agreement, you can go through the whole process without any problem at all. Hopefully, this article will help you understand subordination a little bit better.