What Is a Subordination Agreement, and How Does It Work?

If you’re trying to refinance your home or take out a home equity line of credit (HELOC), you may have come across the term “subordination agreement.” Subordination agreements can seem daunting, but they are a commonly used tool in financing situations where multiple lenders or creditors are involved.

In this article, we’ll demystify subordination agreements, showing you how they work, and why they’re necessary.

A subordination agreement is a legal document that establishes the priority of debt for collecting repayment. This means that in the unfortunate event that the borrower defaults on their loan payments or declares bankruptcy, the priority of debts will dictate the order in which they are paid off.¹

Subordination agreements are commonly used during mortgage refinancing. When you first take out a mortgage, the lender will record the mortgage, called a “first mortgage,” in the land records, creating a lien on your property. However, if you take out another loan, including a home equity loan or HELOC, the lender will record it and get a lien on the property. The second mortgage is referred to as a “subordinate lien.”²

The general rule for mortgage lien is that the lien that’s recorded first typically has a higher priority than subsequent liens. This means that typically, your first mortgage would be paid off from foreclosure proceedings, and the second mortgage would be next in line. Some lines, like property tax liens, may have priority over other liens.³

The priority of debts can become extremely important should a borrower default on their payments or declare bankruptcy. That’s because the higher a debt’s priority the more likely it is to be repaid.⁴

If you have two mortgages and want to refinance the primary loan, the original subordinate loan would then become the primary loan. However, many lenders won’t approve of this refinance since their new loan would then become a subordinate one. In this case, the refinance may be able to move forward only if the original subordinate loan lender agrees to a new subordinate agreement which would out the new lender into the first position. Another alternative would be to refinance both loans into a single mortgage.⁵

In real estate, the new lender is the one that would benefit from a subordination agreement, since it would move them up in priority ahead of the other mortgages. However, since it’s not necessarily to their benefit, existing lenders may not always agree to be subordinate.⁶