Any mortgage you get on a property after the first will be a subordinate mortgage. Common examples of this include second mortgages for home equity loans and home equity lines of credit. In case of a foreclosure, second mortgages’ subordinate status protects the primary lender, ensuring it gets paid first. Should you want to refinance your first mortgage, your refinancing lender will require secondary lenders to sign subordination agreements to maintain this protection. Satisfying this requirement will be easy or difficult depending on your credit rating and income.
Most people who buy homes finance their purchases with a mortgage loan. As they make payments on this first mortgage, they build equity in their homes. Faced with new opportunities or unplanned expenses, many consider accessing that equity by taking out second mortgages. Some who prefer not to have two mortgages may instead look into cash-out refinancing. Some may do both at different times.
The importance of understanding mortgage subordination
Whenever homeowners have more than one mortgage secured by the same property, mortgage subordination becomes important. Every mortgage after the first starts out as a subordinate mortgage. But a first mortgage can lose its primary-loan status and become subordinate through refinancing or modification that fails to take subordination into account. In that case, a mortgage that was formerly second and subordinate could become first and primary.
Are you considering taking out a second mortgage through a home equity loan or home equity line of credit (HELOC)? Thinking about refinancing your first mortgage while you have a second mortgage outstanding? If your answer is “yes” to either question, you should get a handle on subordinate mortgages and mortgage subordination. This article will help you do that.
If you’re in the market for a HELOC, compare multiple lenders before you make up your mind.
What is mortgage subordination?
To subordinate is to place in a position of lower priority or lesser authority. Subordination assigns to something a secondary or lower importance. Mortgage subordination does this with mortgages, making one mortgage subordinate to another. By default, a first mortgage or primary loan takes priority over other, subordinate loans secured by the same property. If a borrower defaults on a home loan, the priority ranking of loans against the property becomes important. When a foreclosure sale happens, this ranking determines which mortgage company will get paid first, which second, and so on.
Mortgage subordination plays a key role in determining the priority ranking of home loans. What allows home loan obligations to be enforced when a borrower defaults are liens against the property. This means that which financial institutions get paid first and which have to wait depends on lien priority. But before we can discuss lien priority, we need to answer a more basic question, namely:
What is a lien?
A lien is a security interest in, or legal claim against, property. It is not itself an agreement, but it is often authorized by one. For instance, as a condition for giving you a home loan, a mortgage lender will require you to sign an agreement. In some states, this will be a deed of trust or something similar, such as a security instrument or security deed. In most states, it will be a mortgage. Along with this agreement, you’ll sign a promissory note, called a mortgage note in the case of mortgages. The note is your (legally binding) promise to pay back your loan. It also set forth the payment terms and the conditions under which you will be in default and subject to foreclosure.
The mortgage is your agreement to the lien that protects the lender if you fail to fulfill this promise. It restates the payment terms and foreclosure conditions laid out in the note and makes them enforceable. Your lender will record the mortgage that creates the lien, typically by filing a notarized copy with the appropriate county office, and will hold onto your note. If your original lender transfers (assigns) your mortgage to another financial institution, that new mortgage holder will hold your note.
Are they all mortgages?
Don’t be surprised if you hear mortgage agreements, mortgage liens, mortgage notes, and mortgage loans all referred to casually as just “mortgages.” This is how most people speak most of the time. Always pay close attention to context to make sure you understand what people mean by “mortgage.”
Whatever its formal title, and however people refer to it informally, the agreement you sign to get your home loan grants your lender a security interest, or lien, against your property. It’s the lien that allows your lender to force the sale of your property through foreclosure should you default on your mortgage loan. Because it’s based on an agreement, this lien is a consensual lien. It can also be called a voluntary lien. Other liens, such as tax liens and judgment liens, are nonconsensual or involuntary. These latter liens can be divided into statutory liens, such as mechanics’ liens and tax liens, and judicial liens, notably judgment liens.
The mortgage note, a promissory note, and the mortgage won’t be the only documents you have to sign when arranging your home financing. For instance, you may sign an escrow disclosure laying out amounts you’ll pay into escrow each month in addition to your principal and interest payments. These additional payments cover things like taxes and insurance, and paying into escrow each month to cover them prevents your having to pay them all at once when they come due. This ensures that your monthly payments remain constant and predictable.
Lien priority and mortgage liens
The general rule for lien priority is “first in time, first in right.” This means that the order of creation determines liens’ priority ranking. Since recording is usually what provides “constructive notice” of a lien, this rule in practice tends to mean “first recorded, first in right,” though recording laws vary by state. In the case of mortgage liens, what gets recorded is the agreement, the mortgage, that creates the lien.
In practice, in fact, mortgages and the liens they create usually get treated as one and the same. Writers and documents routinely call the first mortgage a primary lien and identify mortgages in general as recorded liens. Since the mortgage creates the lien, since there is no lien document separate from the mortgage, and since the legal notice of the lien happens through recording of the mortgage in public records, it’s actually difficult and unnatural to speak of mortgages and their liens any other way.
How to find the right financing
Issues of mortgage subordination and lien priority will only matter to you if you can find and qualify for the right loan. This is why SuperMoney has developed advanced, user-friendly research tools to help you. We combine reviews by real borrowers, reviews not biased by financial incentives, with advanced filters that let you narrow down your search until to find the right set of loans and lenders to consider.
The primary mortgage lien and other liens
A first or primary mortgage is called first or primary for a reason. Typically the first encumbrance on a piece of real estate, it has primary importance by the “first in time, first in right” rule. Law also give primary mortgages first priority in most cases. If you take out junior debt through a second mortgage, as with home equity loans, that junior mortgage will automatically be subordinate to the first.
How does a mortgage become subordinate?
There are exceptions to this rule, however. Several involuntary liens, such as federal tax liens, property tax liens, and liens placed by homeowners associations (HOA) and condominium owners associations (COA), can take priority over mortgage liens, even first mortgage liens.
Is that first mortgage really first?
A so-called silent second mortgage, where a borrower secretly obtains a second mortgage to cover the down payment required for a first mortgage, illustrates how mortgage lien priority can get complicated. Though the silent second is recorded after the first mortgage, preventing the primary lender from finding out about it through a title search, it is actually created first. It has to be created first because it provides the funds that make the primary mortgage possible. Without that silent second, the borrower, lacking sufficient funds for the down payment, would not qualify for the primary mortgage.
Even assuming first mortgage lenders will typically win out when lien priority becomes important due to foreclosure, the complications raised by a silent second create risk and annoyance they’d rather not deal with. Silent second mortgages also increase lender risk by misrepresenting borrowers’ financial resources and existing debt. Borrowers face bigger risks than lenders and can expect much more than annoyance. If they try this maneuver, they could face prosecution for mortgage fraud. So says the FBI.
Understanding subordination clauses and agreements
If you refinance the first mortgage you used to purchase your home after getting a second mortgage, such as with a home equity loan or HELOC, part of the approval process for your refinance will be getting your secondary lender to sign a subordination agreement. For instance, if you take advantage of Fannie Mae’s refinancing option, the lender for your second mortgage will need to sign the appropriate Fannie Mae form. If, instead, you get your Fannie Mae mortgage modified, you’ll need to use a different form.
Subordination and refinancing your home
Because a mortgage refinance replaces your original mortgage with a new one with better terms, the “first in time, first in right” rule would give loans taken out since your first mortgage priority over your refinanced first mortgage. This would mean, for instance, that your HELOC lender could now be first in line to receive money from a foreclosure sale. To avoid this risk, part of the refinancing process will require other lenders to reaffirm the subordinate position of their loans. Some mortgage modifications may also pose a lien-priority risk, in which case the same requirement will likely apply.
What does the subordination clause mean?
The subordination clause in your refinancing agreement will probably (1) indicate your agreement that all other loans against the property will remain subordinate to this new version of your first mortgage and (2) note that your new loan is contingent on properly executed subordination agreements with any secondary mortgage lenders. A few sites out there suggest that (1) is all that matters. The legal reality, however, is that you as a borrower have no authority to change the priority of the debts secured by your property. Whether called junior debt or senior debt, the priority ranking of these debt obligations is a matter of law. You have no authority to make agreements on behalf of the financial institutions that own your debt.
How will subordination affect my financing?
So, a subordination clause in your refinancing agreement doesn’t eliminate the need for subordination agreements signed by your junior lenders. Even so, this requirement won’t affect you much. Though you refinancing agreement, or agreement to certain mortgage modifications, will require subordination agreements between lenders, you may hardly notice. Lenders typically handle these arrangements on your behalf behind the scenes. The loan officer processing your refinance won’t be sending you around to junior lenders to get paperwork signed.
Effect of subordination on refinancing
The main effect of mortgage subordination on your financing, then, will be that refinancing lenders will have a little more work to do. This might lead to some fees. If your credit has deteriorated since you got your first and second mortgages, mortgage subordination could make refinancing harder to get. Why? If you look like a foreclosure risk, the providers of your subordinate financing may not want to sign the required subordination agreements. That’s likely to be a deal breaker for your refinancing lender.
Effect of subordination on a second mortgage
Since lending services that provide loans against your home’s equity know that any such loan becomes a subordinate mortgage, mortgage subordination may not harm your chances for such loan programs as a home equity loan and a HELOC. If you already have some secondary mortgage financing and are looking for more, your new lender will only be able to collect through foreclosure after two prior lenders have been satisfied. In this case, mortgage subordination will make that third round of mortgage financing more difficult to get.
Second mortgages with subordination clauses
Sometimes, paperwork for a second mortgage will include a subordination clause that commits the junior lender to remain subordinate in the event of first-mortgage refinancing or modification. Such a clause in a subordinate loan agreement should make a later subordination agreement unnecessary. This, in turn, could make refinancing your first loan a little easier since preserving its primary status won’t depend on your secondary lender’s willingness to sign a new agreement.
- The basic rule ranking mortgage liens and liens, in general, is “first in time, first in right.” In practice, order of recording rather than order of creation determines lien priority.
- Every mortgage that is not your first mortgage is a subordinate mortgage.
- A subordinate loan could be a home equity loan or a home equity line of credit (HELOC), two common second-mortgage loans.
- Since refinancing replaces one loan with another, a refinanced first mortgage could become subordinate. Getting secondary mortgage-loan providers to sign subordination agreements prevents this.
- Lien priority determines what debts secured by your home get paid first out of foreclosure proceeds. This makes mortgage subordination very important to providers of home loans.
How does a subordination agreement work?
In a subordination agreement, one lender, called the subordinating lender, agrees to have its mortgage loan remain subordinate to the loan of the other lender. If you refinance your first mortgage or have it modified, your refinancing lender will want providers of subordinate financing secured by your home to sign such agreements.
How long does it take to subordinate a loan?
Loan subordination normally happens automatically based on law and the order of the loans. The first home loan recorded has primacy. Each later loan is subordinate to the prior one. In the case of loan subordination dependent on an agreement between banks, the time involved will be however long it takes for the required paperwork to be prepared and signed.
Can a lender refuse to subordinate?
Yes. If a borrower seeking to refinance looks like a foreclosure risk, junior or secondary lenders may refuse to subordinate. If the borrower does not look like a foreclosure risk, however, most lenders will sign subordination agreements when refinancing lenders ask them to do so. In such cases, arranging these agreements is a routine part of refinancing.
What is the purpose of subordination?
The primary purpose of subordination is to ensure that, should default and foreclosure take place, debts secured by a piece of property will get paid in an orderly manner based on the priority of lenders’ claims. One important result of this is to protect the interests of the first or primary lender.
Select acts of subordination may serve additional purposes. For instance, the IRS will sometimes agree with FHA mortgage providers to have federal tax liens made subordinate to a mortgage. In this case, the subordination allows collection on a government-backed mortgage to take priority over collection of unpaid taxes. This, in turn, allows the FHA loan to go through.
Does FHA allow subordinate financing?
If you purchase your home with an FHA-backed mortgage, that first mortgage will have the same priority that any other first mortgage would have. After you’ve built up some equity in your home, you can then seek out subordinate financing, a second mortgage, just like you could with any mortgaged home. If you thereafter want to refinance your FHA mortgage, the same subordination arrangements needed to keep other first mortgages in primary position will be needed to keep your refinanced FHA mortgage in first place.
Alternatives to a silent second mortgage
This isn’t what borrowers usually have in mind when they ask this question, however. Most often, borrowers who ask this question want to know if they can get help covering their down payment when they buy a home using an FHA loan. In other words, they’re looking for legal alternatives to a silent second mortgage. Is such subordinate financing allowed with FHA loans? Yes, it is. In fact, the FHA itself backs such financing. To learn more about this type of financing, read SuperMoney’s complete guide to down payment assistance programs.
What are the two most common types of subordinate liens?
The most common type of subordinate lien is the lien created by a second mortgage. Home equity loans, HELOCs, and piggyback loans (a form of down payment assistance) all result in this type of subordinate lien. Less common subordinate liens include federal tax liens that the IRS has agreed to subordinate and judgment liens against properties that already have mortgages. Though state law often gives mechanics’ liens priority over other liens, these too can be subordinate, as in one Nevada case.
Should you get a subordinate mortgage?
If you borrow against your home’s equity before getting your home-purchase mortgage paid off, your new loan will create a subordinate mortgage. Should you then decide to refinance your home-purchase mortgage, your refinancing lender will ask your subordinate lender to sign a subordination agreement. Signing that agreement keeps the second mortgage subordinate. This means you’ll need good enough credit and income to show you don’t pose a high risk of foreclosure. If your credit and income aren’t good enough, a junior lender might refuse to sign a subordination agreement, which will likely mean your refinancing falls through.
How to qualify for a subordinate mortgage
If your credit and income are excellent, subordinate mortgages shouldn’t stand in the way of refinancing. When borrowers don’t appear at high risk of foreclosure, junior lenders routinely sign subordination agreements when asked to do so by refinancing lenders. As well, you usually won’t have to get involved with subordination agreements yourself. Your lenders will usually work these out for you. All you need to do is maintain excellent credit and sufficient income, carefully research your refinancing options, then apply. SuperMoney’s search tools can get you started.
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