What Is A Subordinate Mortgage?

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

Let’s examine the definition of a subordinate mortgage, how this type of mortgage works and why it’s relevant.

What Is Mortgage Subordination?

Subordination involves the action of placing something in a lower-ranking position.

Mortgage subordination is the process of reorganizing the priority of existing mortgages on a property when a new mortgage is taken out. 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, mortgage subordination won’t come into play until you have more than one lien on your home. But the importance of mortgage subordination will only truly 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 first mortgage loan will be paid off immediately. After that, the subordinate loans will be taken care of with any funds left over from the primary mortgage. These funds are usually obtained via a foreclosure sale.

Understanding A Subordination Clause

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

A subordination clause serves to protect the investors who own a mortgage if a homeowner defaults. If this happens, the investors have 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 only have the chance to recoup their costs after the primary lien holder has been taken care of.

In some cases, the home’s value 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 from. Keep in mind that some financial institutions charge a subordination fee. While subordination fees vary with each lender, they often range from $150 – $400. Pay this fee promptly to avoid delays.

A delay 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 loan can be held at a temporary standstill until the agreement is processed. You will be able to view this agreement at closing as part of your final documentation.

What Mortgage Subordination In Real Estate Means For Borrowers

Now you know what a subordinate mortgage is, but what does this mean for you?

At first glance, it might seem like this clause is only important to the lender and mortgage investors. 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 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 one since the original primary loan will no longer exist.

Most lenders would approve this refinance, but because their loan would be subordinate, there are some exceptions, such as not agreeing to a cash-out refinance or going higher than a max combined-loan-to-value (CLTV) that you will need to verify with your lenders. Sometimes, the refinance can move forward if the original subordinate loan lender agrees to a new subordinate clause.

One way around this scenario is to refinance both loans into a single mortgage with no subordinate clause issues. By consolidating these loans, you're effectively reducing the lender's risk, which makes them more likely to approve.

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 (and investors) will assume more risk as a second mortgage provider, so you can expect a slightly higher interest rate and overall less attractive loan terms. Even if you have a high credit score and a credit report that's in good standing, you might receive a higher rate despite the low risk that you'll default on the loan.

The Bottom Line

Mortgage subordination is a regular occurrence in the lending industry, so it’s possible, but unlikely, that 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.

Now that you know what mortgage subordination is and how it applies to your situation, you should be ready to get your next mortgage. Interested in refinancing or securing a new loan? Start the approval process today.