Subordinate mortgages are those that are behind other recorded liens. When you get a purchase money mortgage -- the loan you get to purchase a home -- this loan must be recorded first on your deed after closing. Should you also get a second mortgage to help you buy the home or receive an equity loan after you own the home, it will be subordinate to your first mortgage, in a lower, less attractive position on the mortgage food chain.
Subordinate Mortgage Explanation
Lenders making mortgage loans that are in second or third position on your recorded deed information have subordinate loans. Since these loans and their collateral are recorded behind primary mortgages and security, the senior liens -- first mortgages -- must be paid off before any subordinate liens can be addressed. This legal reality is the prime reason you'll pay more for second or third mortgages than for your first mortgage. Even first mortgages can become subordinate loans in some situations, as with an Internal Revenue Service lien for unpaid income taxes, which, when filed, automatically becomes a primary lien ahead of your first mortgage, giving it top priority.
How Mortgages Become Subordinate
Any mortgages recorded after the first loan are, by definition, subordinate loans. In some situations, lenders may agree to subordinate their loans to other mortgages, although they don't like to do so. These cases require you to ask the lender to subordinate to another loan. Your reasons and logic had best be strong. In the case of IRS or Mechanics' Liens, a senior mortgage can become a subordinate loan by law or regulation. Your state laws dictate other situations where, through the actions of others, loans can become subordinate without lender agreement.
Reasons Lenders Subordinate Loans
You may wonder why a lender would voluntarily subordinate their loan, weakening their collateral position. However, there are reasons for their agreement. For example, you have a first and second mortgage on your home. You have an excellent payment record. You want to refinance without paying off your second mortgage. You ask your second mortgage lender to agree to subordinate their loan if you refinance, since they would move into first position if you did nothing. The second mortgage lender, happy with your superior payment record and earning monthly interest income, agrees to remain in second position by signing a subordination agreement. This allows you to replace your first mortgage and keep your second mortgage in place.
Reasons Lenders Won't Subordinate
Why turn down a gift? Moving from second or third position to first is tempting for all lenders, with good reason. The case of home loans in a down economy is a perfect example. If you want to refinance your first mortgage and your home's value has declined in a down market, your second mortgage lender, possibly already in a tenuous position because of real estate market decreases, may refuse to subordinate. They may possibly agree to subordinate in return for other consideration, as in cash or a partial pay off through a refinance.
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