Understanding subordinations in real estate

Quick insights

• “Subordination” in a real estate context refers to the order in which lenders have legal rights to possess your home in the event of bankruptcy or foreclosure.
• The main way that lenders will look to possess your home for sale is through acting on a voluntary lien, a legal right granted to them in each loan agreement.
• When a new loan is added to a property’s financing, a subordination agreement may be followed because it formally identifies the hierarchy amongst lenders.

“Subordination” in real estate refers to the order established when multiple lenders have legal rights to a property. A subordination agreement may be created when a homeowner pursues a home equity line of credit (HELOC) or another form of secured financing. The agreement literally determines which lender is repaid first in circumstances like bankruptcy and foreclosure.

While mortgage subordinations mainly exist in the background of homeownership, understanding the basics of how they work can be critical in a few key situations. In this article, we’ll examine subordinations in real estate and explain how to determine if your loan is subject to a subordination agreement.

The basics: Secured loans and liens

Mortgages are secured loans, meaning that there is collateral available to recover if the loan cannot be repaid. In a mortgage agreement, the collateral is the property itself, and a voluntary lien is placed on the property. A voluntary lien is a legal tool that formalizes the lender’s right to possess the collateral and sell the home.

There are other reasons why a lien may be placed on a property. For example, an involuntary lien could be placed for failure to pay property taxes. If you have an involuntary lien on your property, you may need to clear that debt before selling the home. From here on, however, we’ll focus on voluntary liens and how they relate to subordinations in real estate.

Subordination in real estate

It’s common for owners to leverage their home’s value in other ways, such as with a second mortgage or HELOC. However, with each new secured loan added to the property, there is an additional legal right to the home. In most situations, new home-backed debts added by the owner will automatically rank below (or be subordinate to) the primary mortgage loan. The order that dictates which lenders and their liens will follow in the event of bankruptcy or foreclosure is known as “subordination.”

Terminology check: What is a “subordinate mortgage”?

It’s common in real estate for the highest-ranking mortgage to be called the “senior loan” and newer (or lower-ranking) loans to be “junior loans.” If you have a second mortgage on your property, it may also be referred to as the “subordinate mortgage.” In discussions, the term might be used interchangeably with “subordinate lien” because liens are a focus of subordination in real estate.

Setting up subordination clauses and agreements

From a lender’s perspective, ranking lower in terms of lien prioritization makes the loan a higher risk. A lender may require a fee from the borrower or change in loan terms to offset the perceived risk of being lower in subordination order. When the lenders are separate entities, the homeowner will likely be included in the conversation and notified of the subordination agreement.

After lenders negotiate, the typical purpose of a subordination agreement (or clause) is to formalize the loan hierarchy. However, when a new loan or financing agreement is made with the same lender, such agreements may be made internally within the organization.

How to identify if a loan is subordinated

If you’re wondering what the subordination status of your loan is, you can contact your lender. You may also find details about existing subordination in your latest loan agreement. Lien records could be available from your county recorder’s office or website. Otherwise, you may need to request these records over the phone or during an in-person visit.

In conclusion

When it comes to subordinations on real estate that you own, it’s important specific situations. For example, subordination may come up when you’re seeking a new, secured line of credit (such as HELOC) or foreclosure. If you have questions about liens and subordination on your property, contact your lender, consult your loan agreement and maybe get in touch with the county recorder.