Definition
A subordination clause is a clause in a legal document, typically a mortgage or deed of trust, that establishes the precedence of one lien over another in case of borrower default or foreclosure. This clause allows a future or secondary mortgage to take priority over an existing claim, rearranging the traditional first-come, first-serviced order of lien hierarchy. Subordination clauses are essential in real estate refinancing and may be crucial in securing additional financing.
Examples
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Refinancing Example: A homeowner with a primary mortgage and a home equity line of credit (HELOC) decides to refinance the primary mortgage. The lender of the new primary mortgage will require the HELOC lender to sign a subordination agreement allowing the new primary mortgage to take the senior position.
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Development Project: A developer secures initial financing to purchase land and constructs an office building. Later, the developer seeks additional financing for interior work and furnishing. The new lender requests a subordination clause stating that the new loan will hold precedence over the initial mortgage.
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Investment Property Purchase: A real estate investor using a secondary mortgage to purchase an additional rental property ensures that the subordination clause in the second mortgage allows the new mortgage taken on the rental property to become the senior lien, should the primary mortgage on the investor’s residence be refinanced.
Frequently Asked Questions (FAQs)
What is the primary purpose of a subordination clause?
The primary purpose of a subordination clause is to enable or secure additional financing by changing the priority of claims on a property. This is crucial when refinancing existing loans or obtaining new loans that might otherwise be subordinate to earlier debts.
Who benefits from a subordination clause?
Both lenders and borrowers can benefit from a subordination clause. Borrowers benefit by having more options for refinancing and obtaining additional loans. Lenders might be willing to extend credit knowing they hold a primary claim and face less risk.
Is a subordination clause negotiable?
Yes, like many other terms in a contract, a subordination clause can be negotiated between the borrower and the multiple lenders involved. Typically, the lender requiring the subordination clause prepares the documentation for agreement.
Can existing mortgages automatically become subordinate without agreement?
No, for an existing mortgage to become subordinate to another, a formal subordination agreement must be signed by all parties involved. This document is often executed before a notary public.
Related Terms
Mortgage Priority
Mortgage priority refers to the order in which claims on a property are to be settled in case of default or sale. In general, first mortgages must be satisfied before any subordinate mortgages.
Lien
A lien is a legal claim or hold on a property, typically used as security for the payment of a debt or obligation, such as a mortgage or a judgment.
Deed of Trust
A deed of trust is a document that secures a loan on the real estate, acting similarly to a mortgage, with a neutral third party (trustee) holding the title until the loan is repaid.
Home Equity Line of Credit (HELOC)
A HELOC is a loan where the borrower can draw funds as needed, using the home’s equity as collateral. It often requires subordination when refinancing primary loans.
Online Resources
- Investopedia: Subordination Clause
- Nolo: Understanding Subordination Agreements
- HUD: Mortgage Subordination Policies
References
- “The Dictionary of Real Estate Appraisal,” Appraisal Institute.
- “Real Estate Finance and Investment Manual,” Jack Cummings.
Suggested Books for Further Studies
- “The Real Estate Wholesaling Bible,” Than Merrill.
- “Principles of Real Estate Practice,” Stephen Mettling and David Cusic.
- “The Book on Rental Property Investing,” Brandon Turner.
