Loan Subordination Explained

Definition
A subordinating loan agrees to remain in second or third position, behind the first position mortgage.

Why Subordinate
When refinancing a home with more than one mortgage - for example when refinancing a home mortgage that is followed by a home equity line of credit (HELOC) that a homeowner may have accessed to fund a remodel or a landscaping project the HELOC must remain in second lien position. Lien position is determined by the date the lien was recorded, and lien position determines the rights of the lienholder. In the case of liens, timing is everything. The lienholder who recorded first has the most authority, but if the primary lien is refinanced, the secondary lien has the right to agree or disagree with what's happening ahead of it. Banks that issue HELOC rarely make this clear to their applicants.

How To Subordinate
A HELOC subordination involves a formal request of the HELOC lender, usually with the help of your mortgage broker, to "stay in a junior lien position" while the primary mortgage - the one in a superior position - is refinanced. Why must the HELOC lender agree? Because of the timing of liens.

If for example a primary mortgage was refinanced, at the very instant the old mortgage was paid off, the HELOC loan has the legal right to move up one notch on the lien priority ladder! A subordination is a request of the HELOC lender to stay where it is, and not move up a notch. Getting the subordinating lender's agreement is critical. We call this agreement a subordination agreement.

What if the Subordinating Lender Refuses to Allow Subordination?
If the subordinating lender refuses to stay in its inferior position - and we have seen this before - your mortgage refinance may fail or need to be changed. Why? Because the primary mortgage lender wants to be in first position and the agreement of the subordinating lender is mandatory. Think of it as a baseball team's batting order: when a player is substituted, or in the case of a mortgage - refinanced - the order of batters (the mortgage liens) must keep its original order. It's OK to replace a player (or replace a mortgage) but other than the replacement item, no other changes to the batting order.

For those of you not familiar with baseball, here's another analogy. Imagine a card game in which the higher card wins. Your first mortgage represents a King of Hearts, and your HELOC represents a Queen of Hearts. The suit doesn't matter, just the face on the card. The King holds a superior position. Now imagine we want to replace the King of Hearts with a King of Diamonds. We are replacing one King with another King. At the moment we discard the King of Hearts, the Queen has the right to take the throne (!). However, we cannot allow this because it would mean the King of Diamonds will fall into a junior position. Thus we must "block" the Queen. We do this by making a formal request of the Queen to stay where she is, and not jump into the lead position.

The subordinating lender (in the example above, the Queen) will usually - but not always - agree to stay in its inferior lien position, unless the subordinating lender is taking on new risk. However, we have seen HELOC lenders refuse to subordinate in cases in which there is no additonal risk to them. And of course there's going to be a fee involved. How much? Assume something like $250, paid to the HELOC issuer.

What is involved in a Subordination
The subordinating lender will have a checklist of items it wants to review, to ensure it is not taking on more risk. It is common to send the subordinating lender a copy of your home appraisal, primary mortgage loan application, and evidence of income. This is why we ask you to obtain the so called subordination checklist from your HELOC lender - we need to know what they want.

Keeping a subordinated loan can be expensive
Fannie Mae, the largest mortgage funding source in the country, charges a fee if a borrowr wants to subordinate a loan. This fee, expressed as loan points, can be significant. For example, as of January 2016, Fannie Mae reuires that lenders collect a .375% fee - based on the new loan amount - if a borrower wishes to maintain a second or third mortgage. This fee, expecially for the homeowners seeking a mortgage in excess of $250,000, can be significant. Homeowners sometimes conclude it is more cost effective to close out a HELOC for example, and then apply for a new HELOC once their primary mortgage transaction has concluded.

How does the Subordination process conclude?
The subordinating lender will send back a subordination agreement, signaling its acceptance of the mortgage refinance. This agreement gets recorded at the same time your primary mortgage is recorded.