If you are a homeowner /borrower, odds are you have never heard of the term “subordination” as it applies to a mortgage transaction.
But if you are a mortgage holder with both a 1st (primary) mortgage AND a home equity loan or home equity line of credit on the same property, you will find out all about it when/if you be decide to refinance the 1st mortgage.
Just having a home equity line of credit or home equity loan could stop you from refinancing.
Here’s the 411.
If your circumstances should change and you default on your mortgage, the lender would proceed to foreclose. Whichever lender has the 1st (primary) mortgage gets first dibs on the proceeds from the sale of the home through foreclosure. If there are other mortgages – home equity loan, line of credit, even a 3rd mortgage – they can all get in line to get any of the proceeds.
If you decide you want to pay off the primary mortgage and take out a new lower rate loan, that new loan you take out gets in line behind any other loans on the property – without any intervention, that is. But your new lender will have no parts of that. They will only refinance the 1st mortgage if they are guaranteed 1st position – where rightfully they should be. In order to move back to the front of the line, the lender for any other mortgages must agree to sign what’s called a “subordinate agreement.” In layman’s terms, this means the other mortgage lender will “relinquish” their position back to 2nd or 3rd place – whatever it originally was.
So, what’s the big deal?
Many lenders are not signing the subordination document. And what happens if they don’t sign? You don’t refinance. Period. They can hold you over the fire – for a very long time. In order to agree to a subordination, the borrower has to meet the requirements of the home equity lender. If the borrower cannot meet the conditions, there will be no subordination. Some typical conditions by the home equity lender are:
- No late payments on the home equity loan for the past 24 months
- No cash out being taken on the refinanced 1st mortgage
- Maximum combined loan to value for all loans on the property – often 80% max, or lower
- Appraisal review
- Minimum credit score
These requirements are without regard to whether the refinance will place the borrower in a better financial position. Zero common sense is applied. It is a bureaucratic guideline that often makes no sense. I have had quite a few denied where the borrower was going to save enough on the refinance to more than cover the entire monthly payment on the home equity loan.
The majority of smaller banks and credit unions are okay with signing the subordination. But if your home equity loan is with one of the big boys like Chase or Bank of America, get mentally prepared for bad news – unless you have at least 20% equity remaining AFTER subtracting the outstanding mortgages. Some lenders want 30%.
There are 2 crimes against consumers here:
- The fact that the borrower might be compromising their ability to refinance their 1st mortgage SOLELY because this new home equity loan exists was never clearly and adequately disclosed to the borrower (in all likelihood). It should be disclosed on the Truth in Lending Statement at the time the borrower applies for the home equity loan or line of credit. Then the borrower can weigh the pros and cons and decide if the risk is worth it. Or, obtain their home equity loan from another lender who won’t play these games. I can assure you 99% of borrowers who sign the paperwork for a home equity loan have no idea what can happen down the road with subordinations.
- Currently, the subordination guidelines can change at the whim of the home equity lender. Some lenders have revised their policies following the recent decline in property values.
The lender signing the subordination has a fee that must be paid for the administrative work required to do the subordination. This fee is the responsibility of the borrower. It can range from $100.00 to as high as $250.00.
During the period from 2001 to 2004, I did a boatload of FHA Streamline refinances. Many of my clients had home equity loans that had to be subordinated. I never had one declined. Contrast that to today where I have had 10 declined in the past 8 months.
Naturally, if you can pay off the home equity loan as part of the refinance, then you’re in great shape. But if you do not have enough equity to combine everything, you need the subordination.
If you have a home equity loan or line of credit and are thinking about refinancing (and keeping the home equity loan open), give a call and we can see what your possibilities are.
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