The typical problem for homeowners: multiple loans on their property – a first mortgage and a second mortgage. The first mortgage might be an ugly loan with high interest and high monthly payments. The second mortgage (sometimes called an equity line of credit) usually has a low rate and gives homeowners more flexibility to take out money when needed. With their equity line, they can pull money out to pay certain bills that can be paid back later, so their equity line always has credit available.

When homeowners see interest rates on first mortgages are lower than their current interest rate, they decide to refinance. The problem is, they have to either pay off the second mortgage, or get the second mortgage to agree to “Subordinate” their position. Subordinate is a legal term that means “agree to stay in a second position” behind a new loan.

Reasons for a Subordination Agreement

The first loan to be recorded on your property is considered a “first mortgage”. It doesn’t have the name “first mortgage” written on it. If another loan, such as an equity line, is taken out on the property, it is considered a second mortgage, simply because it was the second loan to be recorded on the property.

If you were to inherit some money and pay off the first mortgage, the second mortgage would then be considered a first mortgage, because it would be the oldest mortgage still recorded on the property. Any new loan put on the property would then be considered a second mortgage.

This can create a problem if you want to put a new first mortgage on your property where there is already a loan on the property that you don’t want to pay-off (such as that good equity line). Most lenders that do conventional mortgages require that their loan be in first position.

How A Subordination Transaction Might Work

Current Scenario on your home:

• First Mortgage with A&B Mortgage for $200,000 at 9 percent interest.
• Second Mortgage (Equity Line) with Chase for $50,000 at 5.5 percent interest.

New loan position after refinancing the first:

• New First Mortgage with American Mortgage for $200,000 at 5 percent interest
• Second Mortgage (Equity Line) with Chase for $50,000 at 5.5 percent interest.

The only way this transaction can work like this is if the second mortgage holder (Chase)  signs a subordination agreement allowing the new lender (American Mortgage) to be in first position when American Mortgage creates their loan. If Chase Mortgage wouldn’t sign a subordination agreement with American Mortgage, American Mortgage would have been a second mortgage instead of a first and they wouldn’t have agreed to the loan.

What a Second Mortgage Holder Requires to Sign a Subordination Agreement

Most lenders that specialize in second mortgages such as equity lines of credit, will have their own form of a subordination agreement, and will request a copy of all the information related to the proposed new first mortgage being applied for, namely the loan size and repayment terms. They’ll need the following documents to review the scenario before making the decision to subordinate:

• A copy of the preliminary title report, which shows all loans of record and any changes of ownership that may have occurred since their last loan, such as adding a spouse or a business partner.
• A copy of the current appraisal on the property, so they can ascertain what their equity position will be after they subordinate to a new first mortgage.
• A copy of the new loan mortgage note, which specifies the proposed new loan amount and payback terms.

Why Go Through All This Hassle?

Sometimes when considering a refinance, you may want to leave a certain loan, like an equity line of credit, on the property because it has good terms and offers features you want, like the ability to pull money out when you need it and paying it back when you can. A typical first mortgage doesn’t allow those things. But unless the second mortgage is willing to “subordinate” (or agree to stay in second position), a new lender such as a conventional “first mortgage” lender won’t do a loan, unless they are guaranteed the first position when their loan closes.