What is a subordination agreement, and why does it matter?

July 06, 2020

Refinancing your home comes with its fair share of paperwork. If you have a home equity loan or line of credit, one document may feel particularly daunting: the subordination agreement. Sounds scary, right? Don’t worry. Subordination agreements are a normal part of the refinancing process.

 

Let’s walk through the basics of subordination, using a home equity line of credit (HELOC) as our primary example. Keep in mind that these concepts still apply if you have a home equity loan.

 

What is subordination?

Subordination is the process of ranking home loans (mortgage, HELOC or home equity loan) by order of importance. When you have a home equity line of credit, for example, you actually have two loans – your mortgage and HELOC. Both are secured by the collateral in your home at the same time. Through subordination, lenders assign a “lien position” to these loans. Generally, your mortgage is assigned the first lien position while your HELOC becomes the second lien.

 

Why does subordination matter?

In a foreclosure, your mortgage and HELOC must be paid off with the equity in your home. Unfortunately, a home’s equity cannot always cover the full cost of both loans. Subordination addresses this problem with pre-established lien positions.

The first lien is always paid off first. (In this case, that’s your mortgage.) Equity can only be allocated to pay off the second lien once your mortgage is paid in full. If there were a third lien, it would be paid off after the second lien. And so on.

When there’s not enough equity to cover what’s owed on your second lien, the HELOC lender loses money. Subordination cannot magically pay off loans, but it does help lenders estimate risk and set appropriate interest rates.

 

How does subordination affect refinancing?

Refinancing is the process of paying off your old mortgage and replacing it with a better one. When your mortgage is paid in full, the second lien (HELOC) automatically bumps up in priority. Your HELOC becomes the first lien, and your new mortgage becomes the second lien.

Unsurprisingly, mortgage lenders don’t like the risk associated with a second lien. A subordination agreement allows them to reassign your mortgage to first lien and your HELOC to second lien position.

 

What can you expect?

Most subordination agreements are seamless. In fact, you may not realize what’s happening until you’re asked for a signature. Other times, delays or fees may take you by surprise. Here are a few important notes about the subordination process.

  • Subordination agreements are prepared by your lender. The process occurs internally if you only have one lender. When your mortgage and home equity line or loan have different lenders, both financial institutions work together to draft the necessary paperwork.
  • Some financial institutions charge a subordination fee and/or other fees, such as appraisal fees.
  • Delays can occur, especially if you have two lenders. We encourage you to manage this situation to ensure that your subordination agreement is completed before the loan closing date.
  • Your home equity loan or HELOC may be frozen or closed temporarily until the subordination agreement is processed.

 

Make your home refinance possible

Despite its technical-sounding name, the subordination agreement has one simple purpose. It assigns your new mortgage to first lien position, making it possible to refinance with a home equity loan or line of credit. Signing your agreement is a positive step forward in your refinancing journey.

 

 

 

If you have questions about subordination, we’re here to help. Make an appointment with us today.

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