A subordination agreement is a legal contract that establishes the order of repayment for various debts or loans in the event of foreclosure or bankruptcy. It is commonly used in situations where a borrower has multiple loans secured by the same collateral, such as a home.
Key Facts
- Definition: A subordination agreement is a legal contract that establishes the priority or ranking of different debts or loans in terms of repayment in the event of foreclosure or bankruptcy.
- Purpose: The main purpose of a subordination agreement is to determine the order in which debts will be repaid. It helps lenders assess risk and set appropriate interest rates by establishing a hierarchy of repayment priority.
- Home Loans Example: In the context of home loans, subordination agreements are commonly used when a homeowner has both a mortgage and a home equity line of credit (HELOC) or a home equity loan. The mortgage is typically assigned the first lien position, while the HELOC or home equity loan becomes the second lien.
- Foreclosure and Bankruptcy: In the event of foreclosure or bankruptcy, the first lien (e.g., the mortgage) is paid off first, and any remaining equity is allocated to pay off the second lien (e.g., the HELOC or home equity loan). If there are additional liens, they are paid off in order of priority.
- Refinancing: Subordination agreements also play a role in refinancing. When a mortgage is paid off in full, the second lien (e.g., the HELOC) automatically moves up in priority. A subordination agreement allows mortgage lenders to reassign the lien positions, making it possible to refinance with a home equity loan or line of credit.
Purpose of Subordination Agreements
The primary purpose of a subordination agreement is to determine the order in which debts will be repaid. This helps lenders assess risk and set appropriate interest rates by establishing a hierarchy of repayment priority.
Example: Home Loans
In the context of home loans, subordination agreements are often used when a homeowner has both a mortgage and a home equity line of credit (HELOC) or a home equity loan. The mortgage is typically assigned the first lien position, while the HELOC or home equity loan becomes the second lien.
Foreclosure and Bankruptcy
In the event of foreclosure or bankruptcy, the first lien (e.g., the mortgage) is paid off first, and any remaining equity is allocated to pay off the second lien (e.g., the HELOC or home equity loan). If there are additional liens, they are paid off in order of priority.
Refinancing
Subordination agreements also play a role in refinancing. When a mortgage is paid off in full, the second lien (e.g., the HELOC) automatically moves up in priority. A subordination agreement allows mortgage lenders to reassign the lien positions, making it possible to refinance with a home equity loan or line of credit.
Conclusion
Subordination agreements are appropriate when multiple loans are secured by the same collateral. They establish the order of repayment in the event of foreclosure or bankruptcy, helping lenders assess risk and set appropriate interest rates. In the context of home loans, subordination agreements are commonly used to prioritize repayment between mortgages and HELOCs or home equity loans.
Sources
- Investopedia: Subordination Agreement
- U.S. Bank: What’s a Subordination Agreement, and Why Does It Matter?
- FINRA: Subordination Agreements: Understand the Risks
FAQs
What is a subordination agreement?
A subordination agreement is a legal contract that establishes the order of repayment for various debts or loans in the event of foreclosure or bankruptcy.
When is a subordination agreement appropriate?
Subordination agreements are appropriate when multiple loans are secured by the same collateral, such as a home. They are commonly used to prioritize repayment between mortgages and home equity lines of credit (HELOCs) or home equity loans.
What is the purpose of a subordination agreement?
The purpose of a subordination agreement is to determine the order in which debts will be repaid. This helps lenders assess risk and set appropriate interest rates.
What happens in the event of foreclosure or bankruptcy if there is a subordination agreement?
In the event of foreclosure or bankruptcy, the first lien (e.g., the mortgage) is paid off first, and any remaining equity is allocated to pay off the second lien (e.g., the HELOC or home equity loan). If there are additional liens, they are paid off in order of priority.
How does a subordination agreement affect refinancing?
When a mortgage is paid off in full, the second lien (e.g., the HELOC) automatically moves up in priority. A subordination agreement allows mortgage lenders to reassign the lien positions, making it possible to refinance with a home equity loan or line of credit.
Who prepares subordination agreements?
Subordination agreements are typically prepared by the lender. However, if the borrower has multiple lenders, both financial institutions will work together to draft the necessary paperwork.
Are there any fees associated with subordination agreements?
Some financial institutions charge a subordination fee and/or other fees, such as appraisal fees.
Can subordination agreements be delayed?
Yes, delays can occur, especially if the borrower has multiple lenders. It is important to manage this situation to ensure that the subordination agreement is completed before the loan closing date.