There’s a lot of complicated vocabulary involved in the mortgage process. It can start to feel like you need a dictionary to understand the terms everyone is referencing. DTI, LTV and amortization are just a few of the new vocab terms you’ll need to cover.
Subordination only comes up in certain situations in the mortgage process, but it’s still helpful to be familiar with what it means and the importance it might have when it comes to your home financing. That’s what we’re going to go over today.
First, it may help to have a basic definition of subordination itself. If you have a boss or a leader you report to in the workplace, you’re a subordinate of that person. You do your job, but ultimately the team leader is responsible for making sure that everyone is rowing in the same direction. The decisions of the leader take priority.
Working from this basic definition, we can now begin to apply the concept of “subordination” to mortgages.
What Is a Subordinate Clause in a Mortgage?
Subordination clauses in mortgages refer to the portion of your agreement with the mortgage company that says their lien takes precedence over any other liens you may have on your property. Let’s back up a bit because we have a vocab term within a vocab definition. Very meta, I know.
A lien is basically something placed on a piece of property that says someone has the right to repossess a property if you don’t make the payments on a debt that you have. The primary lien on a house is usually a mortgage. However, it’s also possible to have other liens. You might have some placed by contractors until work is paid off. For instance, maybe you got some solar panels installed and still owe on them.
The important thing to know is that in the event that you run into financial trouble and end up defaulting on your mortgage, whichever lien has first position on the title has its loan paid off first. Every other lien is subordinate to the first one in terms of payoff.
How Subordinate Financing Impacts Your Mortgage Options
If you have subordinate liens on your home, it can impact your ability to qualify for mortgage financing. In some cases, depending on the mortgage investor and the lien, you may or may not be able to qualify to purchase a new home or get a mortgage in the future.
As an example, let’s say you have some unpaid tax liens. On a refinance, you can only get an FHA loan if the IRS liens are subordinate to your mortgage financing. This is something the IRS may or may not agree to. No other mortgage investors allow you to get a mortgage with unpaid tax liens.
With other types of subordinate financing, including home equity loans, contractor liens, etc., the lender will have to review these subordinate liens to make sure the payments remain constant, there’s no negative amortization (meaning the payments you make don’t actually pay the loan off) and so forth. There can also be restrictions around the timing of balloon payments, among other things.
Subordinate Mortgage Loan Modification
If you’ve had any kind of financial struggles in the past, you may have a modification on your subordinate mortgage. This can be a good thing, as it’s used to help you get back on your feet. However, if you’re applying for a new primary mortgage, your lender needs to know about the modification so that they include the proper amount in your monthly debt-to-income (DTI) ratio.
If the amount you’re paying doesn’t match the amount on your credit report, you’ll need to provide a subordination agreement with the modified loan or a copy of the modification agreement that shows your payment amount.
Rates and Second Mortgages
If you’ve been considering a second mortgage, it’s important to note that because the second mortgage is subordinate to the first one and the primary mortgage gets paid off first, second mortgages are more risky for the lender and mortgage investor.
In exchange for taking the chance, the lender will charge you a higher rate than you could get on a primary mortgage. It’s definitely something to consider if you’re looking at a second mortgage or HELOC.
On the other hand, you can choose to utilize the equity in your home to combine your first and second mortgages into one primary mortgage, which could help you get a better rate. If this is something you’re interested in, you can check out your options online through Rocket Mortgage by Quicken Loans or go ahead and give one of our Home Loan Experts a call at (800) 785-4788.