What Is a Subordination Agreement, and How Does It Work?
4 Min Read | Published: May 8, 2024
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A subordination agreement can be used to rank home loans in order of priority. Learn how subordination agreements work and what this means for you.
At-A-Glance
- In real estate, a subordination agreement can be used to adjust the priority of mortgages to give a refinance loan top priority.
- Subordination agreements can help to establish a clear lien position hierarchy. This can be useful in the event of debt repayment scenarios like foreclosure.
- The need for a subordination agreement may arise when there are multiple loans on a property.
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.
What Is a Subordination Agreement?
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
Why Does Subordination Matter?
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
Why Are Subordination Agreements Used In Refinancing?
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
Who Benefits From a Subordination Agreement?
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
Frequently Asked Questions
Typically, the new lender will prepare the subordination agreement, working with the subordinating lienholder. In some cases, both parties will sign the agreement but in others, only the subordinating lender will need to sign.7
Subordination agreements are important when refinancing because they reorganize and re-prioritize the different lien holders when new mortgage financing is involved.
Subordination agreements generally consist of the primary lender or mortgage holder, the secondary lenders or lienholders, and the borrower. The agreement clarifies the repayment priority of each creditor to ensure a structured and fair approach to debt settlement.
The Takeaway
Subordination agreements are commonly used during mortgage refinancing and establish the priority of different liens. Understanding how they work can help you to navigate the process with ease.
1,4 “Subordination Agreement: Definition, Purposes, Examples,” Investopedia
2,3,6,7 “What Is a Subordination Agreement in Real Estate?,” NOLO
5 “What To Know About A Subordinate Mortgage,” Rocket Mortgage
Kaelynn Midgley is a writer and content marketing strategist. She creates practical content on budgeting, saving, investing, taxes, and all aspects of personal finances.
All Credit Intel content is written by freelance authors and commissioned and paid for by American Express.
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