What Is a Mortgage Subordination Agreement?
Understand how mortgage subordination agreements formally reorder the payment priority of financial claims secured by real estate.
A mortgage subordination agreement is a legal document that adjusts the priority of debts secured by real estate, establishing which claim is superior for repayment. This agreement determines the order in which creditors are paid from a property’s value, especially in foreclosure or sale, when multiple loans or liens exist.
Understanding Lien Priority
A “lien” represents a legal claim against a property, serving as security for a debt. When a mortgage lender provides a loan, they place a lien on the property, giving them a right to the asset if the borrower defaults. Multiple liens can exist on a single property, such as a first mortgage, a second mortgage, or other claims like judgment liens or tax liens.
Lien priority dictates the order in which these claims are satisfied from the proceeds if the property is sold or foreclosed upon. Generally, priority is established by the “first in time, first in right” rule, meaning the lien recorded first in public land records typically holds the highest priority. For example, the initial mortgage used to purchase a home is usually recorded first and thus holds the primary or “senior” lien position.
In a foreclosure sale, the proceeds are distributed to lienholders based on their priority, with the highest priority lien being paid first. If the sale proceeds are insufficient to cover all debts, lower-priority (or “junior”) lienholders may receive only partial payment or nothing at all.
How Subordination Changes Priority
A mortgage subordination agreement is a voluntary contract where a lienholder agrees to lower their claim’s priority position. This means a debt that would typically hold a higher rank based on its recording date agrees to become junior to another, usually newer, debt. This process essentially moves a loan down the repayment hierarchy, altering the original “first in time” rule.
The agreement is typically signed by the existing lienholder who is agreeing to subordinate their position. For example, a second mortgage lender might agree to subordinate their lien to a new first mortgage. This change directly affects the order of repayment in a forced sale or foreclosure.
The lender who agrees to subordinate takes on increased risk because their claim will now be paid after the newly prioritized loan. Despite the increased risk, lenders often agree to subordination to facilitate transactions that benefit the borrower, such as refinancing into a more favorable interest rate.
The agreement ensures that the new primary lender, providing a larger loan, maintains the most secure position. Without such an agreement, the new loan would automatically fall behind existing liens, making it less attractive or even impossible for the new lender to approve.
Typical Situations Requiring Subordination
Mortgage subordination agreements are commonly required in specific real estate transactions, primarily involving refinancing or obtaining additional financing. One frequent scenario occurs when a homeowner refinances their existing first mortgage while also having an active second mortgage or Home Equity Line of Credit (HELOC). When the original first mortgage is paid off and replaced by a new one, the existing second mortgage would normally automatically move into the first lien position because it becomes the oldest recorded lien.
To prevent this automatic shift and ensure the new, refinanced mortgage maintains the primary lien position, the new first mortgage lender will typically require the second mortgage or HELOC lender to sign a subordination agreement. This agreement contractually obligates the second lienholder to remain in their junior position, behind the new first mortgage. Without this, the new first mortgage lender faces higher risk and may decline to approve the refinance.
Another common instance involves obtaining a new second mortgage or HELOC when a first mortgage already exists. The new second mortgage or HELOC will naturally be subordinate to the existing first mortgage because it is recorded later. While the first mortgage holder typically does not need to subordinate, their existing loan agreement may outline requirements if the borrower seeks additional financing.
The Subordination Process
The process of obtaining a mortgage subordination agreement typically begins when a borrower applies for a new loan, such as a refinance, that necessitates a change in lien priority. The new lender, or the borrower, initiates a request to the existing lienholder who needs to subordinate their position. This request often includes details of the new loan and the borrower’s financial information.
Upon receiving the request, the existing lienholder, often a bank, conducts a review. This review assesses various factors, including the borrower’s creditworthiness, the property’s current equity, and the terms of the new loan. Lenders evaluate the risk associated with maintaining their lien in a subordinate position.
If the review is favorable, the existing lienholder drafts a formal subordination agreement. This legal document specifies the terms under which their lien will be re-prioritized. The agreement is then signed by the necessary parties, primarily the lender who is agreeing to subordinate and, in some cases, the borrower.
Finally, the executed subordination agreement is recorded in the local public land records. Recording the document provides public notice of the change in lien priority, legally effectuating the new order of claims against the property. The process can take several weeks, with some lenders charging a fee, often ranging from $150 to $400, for processing the agreement.