What To Know About A Subordinate Mortgage

As you learn more about homeownership, you’ll likely encounter dozens of terms you’ve never seen before. One of these terms is “mortgage subordination” and its corollary, “subordinate mortgage.”

You can likely guess that understanding the meaning of a subordinate mortgage is important. Why else would we be discussing it? Let’s examine the definition of a subordinate mortgage, how this type of mortgage works and why it’s relevant.

What Is A Subordinate Mortgage?

Subordination in itself is the act of placing something in a lower-ranking position.

Mortgage subordination boils down to a ranking system on the liens secured by your home. A lien is a legal agreement that grants the lender a right to repossess the property if you default on the loan. The order of subordination is determined based on the type of loan against your property.

If you only have one home mortgage and no other liens, you’ll find that mortgage subordination won’t come into play until you have more than one lien on your home. But the importance of mortgage subordination will truly only reveal itself if a homeowner defaults on their mortgage loan.

Let’s say a borrower ends up in financially dire straits and defaults on their mortgage. At that point, the main mortgage loan will be paid off first. After that, the subordinate loans will be taken care of with any funds left over from the primary mortgage.

Understanding Subordination Clauses

When you get a mortgage loan, the lender will likely include a subordination clause essentially stating that their lien will take precedence over any other liens placed on the house.

A subordination clause serves to protect the lender if a homeowner defaults. If this happens, the lender then has the legal standing to repossess the home and cover their loan’s outstanding balance first.

If other subordinate mortgages are involved, the secondary liens will take a backseat in this process. The subordinate liens would only have the chance to recoup their costs after the primary lender has been taken care of.

In some cases, the value of the home won’t be enough to cover all of the liens. In this situation, subordinate lenders are in a riskier financial position than the primary mortgage lender.

The Mortgage Subordination Process

Most mortgage subordination agreements will likely run smoothly, but fees and delays can interfere with the process. The first step is taken by your mortgage lender to get the necessary paperwork, and the lender will work with any other financial institutions that you borrowed a loan from. Keep in mind that some financial institutions charge a subordination fee.

Delays can occur if you have more than one lender, so make sure your subordination agreement is all set and ready to go before the closing date. If you don’t get the agreement in on time, your home equity loan or HELOC can be held at a temporary standstill until the agreement is processed.

What Mortgage Subordination In Real Estate Means For Borrowers

Now you know what a subordinate mortgage is, but how does this affect you?

At first glance, it might seem like this clause is only important to the lender. But a mortgage subordination clause can impact your finances. Here’s what to watch out for.

Refinancing Your Home

If you want to take advantage of lower interest rates by refinancing a mortgage, a mortgage subordination clause could present a roadblock.

Let’s say you already have two mortgages and want to refinance the primary loan. When refinancing, the original subordinate loan would become the primary loan since the original primary loan will no longer exist.

Many lenders won’t approve this refinance because their loan would be a subordinate loan. Sometimes, the refinance can move forward if the original subordinate loan lender agrees to a new subordinate clause. It might not work out, though.

One way around this scenario is to refinance both loans into a single mortgage with no subordinate clause issues.

Getting A Second Mortgage

A second mortgage will become a subordinate loan. If you repay the primary loan within the term of the second mortgage, the second mortgage can take its place as the primary loan.

A lender will assume more risk as a second mortgage provider, so you can expect a slightly higher interest rate and overall less attractive loan terms.

The Bottom Line

Mortgage subordination is a regular occurrence in the lending industry, so it’s possible (but unlikely) you’ll deal with this clause at some point in your homeownership journey. As the borrower, mortgage subordination likely won’t affect you unless you have additional liens on the property.

Not sure if the mortgage subordination clause in your loan is a good one? Speak with a Home Loan Expert about the details of your unique situation.