What Is a Subordinated Loan?

• Subordination occurs when a loan that is a junior lien remains a junior lien (in second lien or second mortgage position) after a senior lien (first mortgage) is paid off and replaced with a new one. The determining factors for a senior lien and a junior lien are the dates on which they were filed. For example: Your old first mortgage was filed on June 1, 2008, and your second mortgage was filed on December 1, 2008. The later date makes the second mortgage a second lien on the property. If the first mortgage is refinanced and paid off, the mortgage which was filed on December 1, 2008 would move to the first lien position, putting the newly refinanced first mortgage in second lien status. Since the second mortgage filed on December 1, 2008 is being subordinated, it will remain in second lien position, giving priority to the new first mortgage.
  
  

Lender Must Approve

• Your new lender must approve the subordination of the second mortgage. The payment of the new first mortgage along with all other monthly payments (including the existing second mortgage payment) must be calculated, and the new debt ratio must be approved. There should be no late payments on the second mortgage in the past 12 months. An acceptable subordination agreement must be approved by the new lender, executed and filed in county records.
  
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Benefits

• The benefit of subordination is that the second mortgage is not being paid off, so the first mortgage can be a smaller loan. If you are decreasing your interest rate to decrease the payment of your first mortgage (which is long term debt), you will decrease it more if the balance of the second mortgage is not included. The second mortgage is normally considered to be short term debt and is easier for the borrower to accelerate and pay off early.
  
  

Considerations

• By subordinating the second mortgage, the borrower still has the use of the equity which the second mortgage was taken out for. This is particularly true if the homeowner took out a HELOC (home equity line of credit) and has not used up the entire credit line.
  
  

Warning

• Notify the lenders early in the process of refinancing your first mortgage if you prefer to subordinate your second mortgage rather than include it in the new mortgage amount. While it is not a problem to subordinate it, waiting until the last minute can slow down your loan process. The first mortgage lender must approve the subordination, and the second mortgage lender must be notified. Also, the subordination agreement must be sent to the second mortgage lender's legal department, and it must be returned to the new lender and the closer. This process can cost you a few extra days.