Using a Subordination Agreement to Refi a First Mortgage While Keeping a Second

March 15, 2017

What if you have a first and second mortgage on your home, but you want to refinance the first mortgage only? Maybe your current second mortgage has a very low interest rate that you don’t want to lose. If so, you can use a subordination agreement to do the refi on the first mortgage, while keeping the second mortgage exactly where it is.

What is a Subordination Agreement?

A subordination agreement is where one mortgage lender agrees to subordinate their lien in favor of another mortgage on the same property.

It’s most common in connection with mortgage refinancing, where there are two mortgages on the same property. The two mortgages are comprised of either a first mortgage and a second mortgage, or a first mortgage and a home equity line of credit (HELOC).

Mortgages are based on priority liens. That means that priority is based on the order in which a mortgage is recorded. As such, in the event of a default, the first mortgage holder has a priority claim on the property securing the loan, while the second mortgage holder has a second priority.

That means that in the event of foreclosure, proceeds from the sale of the property will first be used to satisfy the first mortgage. This will leave the second mortgage holder to settle the debt only with whatever sales proceeds are left over.

In the normal course of events, once a first mortgage is paid, the second mortgage or HELOC then moves up to the first lien holder position.

This can present a problem if you have two mortgages and want to refinance the first. The new first mortgage holder will only do the refinance if the second mortgage holder agrees to remain in the second lien position behind the new first mortgage.

Why You Might Want to Do a Subordination Agreement

A subordination agreement becomes necessary where the property owners want to refinance the first mortgage but retain the second mortgage or HELOC. The owners may want to refinance the first mortgage into a more favorably priced one, or into one with a shorter term.

Normally, a refinance might be accomplished involving both a new first and a new second mortgage. But the owners may want to keep the original second because it offers a favorable interest rate, or because they are close to paying the loan off, or perhaps they even prefer dealing with the bank that provided that loan.

They may be able to refinance the first mortgage and leave the second exactly where it is, as long as the second mortgage holder is willing to provide a subordination agreement.

With the subordination agreement, the second mortgage holder agrees to move into the second lien position behind the new first mortgage. That will enable the new first mortgage to move into the first lien position upon closing on the loan.

How to Do a Subordination Agreement

As the mortgage borrower, you generally won’t have to do too much to get a subordination agreement. Though the new first mortgage lender may have you complete certain paperwork, the actual negotiations for the agreement will largely take place between the closing attorney or title agent, and the lenders themselves.

A subordination agreement from the second mortgage holder isn’t automatic. Naturally, the second mortgage lender will be more likely to agree to subordination if you have a good payment history on the loan, and it is currently paid up to date. If you’ve had a history of late payments, the second mortgage lender may be unwilling to give up their lien position for the new loan.

But if the second mortgage holder agrees to the subordination, you will be able to close on the new first mortgage, by simply replacing the original first mortgage holder with the new one.

Example of a Subordination Agreement

Let’s say that five years ago you purchased your home for $400,000. You did so with a $320,000 first mortgage and a $40,000 second mortgage. The original first mortgage was a 30 year fixed rate loan, while the second was a 15 year fixed rate loan at 4.00%.

The interest rate on your first mortgage is 5.00%, and you are now interested in refinancing that loan into a new 30 year fixed rate mortgage at 4.00%.

Unfortunately, you discover that interest rates on second mortgages have increased to 5.00%. That makes you unwilling to give up your second mortgage so easily. Also, since you’re five years into your second mortgage, you only have 10 years remaining until it’s completely paid off.

You decide to go ahead and refinance with a new first mortgage. But you also stipulate that you want your existing second mortgage to remain in place. For that to happen, the second mortgage holder will have to agree to subordinate their mortgage to the new first mortgage.

Since you’re current on your second mortgage, and you’ve never had a late payment, the second mortgage holder executes the subordination agreement, enabling you to go ahead with the refinance of your first mortgage.

You are now in a win-win situation. You’ll get the benefit of the lower interest rate on your new first mortgage while retaining the lower interest rate of your original second mortgage.

The Cost of a Subordination Agreement

There typically will be a fee to be paid when you get a subordination agreement. Since there are so many different second mortgage lenders, the subordination agreement fee can vary widely from one lender to the next.

Some lenders may charge a modest fee, such as $150-$250. But others may charge considerably more, even as high as $750 or more.

If the fee is on the higher side, you’ll want to seriously consider if it might be more cost effective to simply replace your current second mortgage with a new one. This is especially important if the amount of the second mortgage is relatively low, and the fee is high. For example, if the remaining balance on your second mortgage is $20,000, and the fee for the subordination agreement will be $800, that will be the equivalent of 4% fee for the agreement.

The good news is that the subordination agreement fee doesn’t necessarily have to be paid out pocket. It can be collected at the closing table. And if so, the cost can be made out of the additional proceeds of your refinance that are used to cover your overall closing costs.

If you’re looking to do a refinance of your first mortgage, but you’re worried about losing a beneficial second mortgage, a subordination agreement may be exactly what you need. The new first mortgage lender will most likely suggest it to you to you. And if they do, you can know that the situation will be well in hand.

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