What is a subordination agreement, and why does it matter?

What is a subordination agreement, and why does it matter?

Refinancing your home comes with its fair share of paperwork. If you have a home equity loan or line of credit, one document may feel particularly daunting: the subordination agreement. Sounds scary, right? Dont worry. Subordination agreements are a normal part of the refinancing process.

Lets walk through the basics of subordination, using a home equity line of credit (HELOC) as our primary example. Keep in mind that these concepts still apply if you have a home equity loan.

What is subordination?

Subordination is the process of ranking home loans (mortgage, HELOC or home equity loan) by order of importance. When you have a home equity line of credit, for example, you actually have two loans Ђ“ your mortgage and HELOC. Both are secured by the collateral in your home at the same time. Through subordination, lenders assign a Ђњlien positionЂќ to these loans. Generally, your mortgage is assigned the first lien position while your HELOC becomes the second lien.

Why does subordination matter?

In a foreclosure, your mortgage and HELOC must be paid off with the equity in your home. Unfortunately, a homes equity cannot always cover the full cost of both loans. Subordination addresses this problem with pre-established lien positions.

The first lien is always paid off first. (In this case, thats your mortgage.) Equity can only be allocated to pay off the second lien once your mortgage is paid in full. If there were a third lien, it would be paid off after the second lien. And so on.

When theres not enough equity to cover whats owed on your second lien, the HELOC lender loses money. Subordination cannot magically pay off loans, but it does help lenders estimate risk and set appropriate interest rates. Continue reading “What is a subordination agreement, and why does it matter?”