Subordination

Subordination in Real Estate

Definition

Subordination is a legal process in which a lender agrees to change the order of priority of its claim on a property. This typically involves a higher-priority lien, such as a first mortgage, being relegated to a lower priority such as a second mortgage. Subordination is essential in financing arrangements where new loans are required for property development, refinancing, or other significant financial obligations.

Detailed Explanation

In real estate financing, subordination can occur when a property owner wishes to secure additional financing but the property already has an existing mortgage or lien. To facilitate the new loan, the existing lender may agree to subordinate their lien, meaning their right to the property’s proceeds is reduced in priority compared to the new lender. This is often seen with development loans, where the land seller holding a first mortgage agrees to subordinate to allow the new development loan, under the assurance that the original mortgage will be retired within a specified period.

Examples

1. Residential Development Financing

   • A homeowner has a first mortgage but wants to secure a home equity loan to fund renovations. The mortgage lender agrees to a subordination agreement, making room for the home equity loan to take precedence in certain conditions.

2. Commercial Development

   • A commercial real estate developer holds a first mortgage but needs additional financing for a new building. The existing mortgage lender subordinates their position to the new development loan to ensure cash flow for the project with an arrangement for mortgage retirement within a specified timeframe.

3. Land Purchase and Development

   • A land seller holds a first mortgage on the purchased property. To enable the buyer to obtain financing for development, the seller agrees to subordinate, which allows the development loan to take a superior position temporarily.

Frequently Asked Questions (FAQs)

1. Why would a lender agree to a subordination agreement?

• Lenders may agree to subordination to facilitate the borrower’s ability to secure additional funding, which might improve their loans’ security over time, particularly if the additional funding results in enhanced property value.

2. Does subordination affect the interest rates of a mortgage?

• Subordination itself does not necessarily affect the interest rate, but it may influence the terms of new loans as lenders often evaluate the changed risk status.

3. Is subordination permanent?

• Subordination is typically outlined within specific time frames or conditions and is binding until those conditions are met, such as the retirement of a particular mortgage.

4. Are subordination agreements legally binding?

• Yes, subordination agreements are legally binding contracts recognized by financial institutions and courts.

5. Can a borrower request subordination?

• Borrowers can request subordination from existing lenders, but the acceptance depends on lender policies and the viability of the borrower’s new financial plans.

Related Terms

• First Mortgage:

  • The primary loan taken out on a property, which holds the first lien position.

• Second Mortgage:

  • A loan secured against a property that is subordinate to the first mortgage in terms of priority.

• Lien:

  • A legal claim or right against a property by a lender or creditor to ensure repayment of a debt.

• Re-Financing:

  • The process of obtaining a new loan to pay off an existing mortgage, often involving renegotiation of terms.

• Development Loan:

  • A loan specifically obtained to finance the development of land or build structures on a property.

Online Resources

1. Investopedia - Subordination
2. The Balance - Understanding Mortgage Subordinations
3. BankRate - What is a Subordination Agreement?

References

1. “Real Estate Finance and Investments” by William Brueggeman and Jeffrey Fisher.
2. “Investing in Real Estate” by Gary W. Eldred.
4. “Commercial Real Estate Analysis and Investments” by David M. Geltner and Norman G. Miller.

Suggested Books for Further Study

1. “Real Estate Finance and Investments” by William Brueggeman and Jeffrey Fisher
2. “Investing in Real Estate” by Gary W. Eldred
3. “Commercial Real Estate Analysis and Investments” by David M. Geltner and Norman G. Miller
4. “Real Estate Investment: A Strategic Approach” by David Moffat

Real Estate Basics: Subordination Fundamentals Quiz