Table of Contents
- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
About Subordinate Financing
When you plan to buy a home you have multiple options to pay for the home with the most common being taking out a mortgage.
When you take a mortgage to buy a home that mortgage is the first lien on the property.
However, there might be an instance where you take a second lien on the property like a home equity loan.
The home equity loan in this case is subordinate financing. In this post, we will learn more about what is subordinate financing in detail.
What Is A Subordinate Financing?
When you take the first mortgage to purchase a property that acts as a senior lien, any other loan taken on the same property is known as subordinate financing or junior lien.
Any financing taken on the same property through the home equity after the first mortgage is called a subordinate loan. Lien positioning is the key to subordinate lien.
When you take out the first mortgage your lender will update the public records stating that this is going to be a lien on the property with your property as collateral for the loan.
Now when you take out a home equity line of credit it will again be recorded as a lien with your property as collateral by the lender you took the HELOC from.
In this case, the mortgage was recorded first hence it would become the senior lien and the HELOC was recorded after that so the HELOC becomes the junior lien.
Why Is Subordinate Financing Important?
It is in the interest of the lenders in case of multiple liens if the borrower is unable to pay for his or her obligation on the liens.
If the borrower fails to pay his or her mortgage payments, the property is likely to be foreclosed. If the property is sold to pay off the creditors, the proceeds are used to payoffs these liens based on the lien position.
The senior lien will get paid first and if any proceeds are remaining the subordinate loan will be paid after.
After paying the senior lien, there are not enough proceeds left to pay the junior lien, the lender has to choose another option to collect the money from the borrower.
This is the only reason why a lender will charge a higher interest rate on a home equity line of credit or a second mortgage compared to what you can get on a first mortgage because of the risk they face due to their lien position.
Does A Subordinate Financing Change Into A Senior Loan Or Vice Versa?
There is always a possibility of the lien position being changed depending on the situation.
Let’s say that you have the first mortgage you took out for 15 years and a second mortgage a few years later for home improvement.
In this case, your second mortgage would be a subordinate lien. Now, you paid off your first mortgage before you could pay off your second. In such a situation, your subordinate lien will become a senior lien.
In another situation, if you have a first mortgage which is by default a senior lien on the property and IRS puts a claim on the property as a lien for unpaid income taxes, or your county puts a lien on your property for unpaid property taxes.
These types of liens are by default positioned as senior liens and pushes down your mortgage to a subordinate lien position.
When Does It Make Sense To Get Subordinate Financing?
There could be multiple situations where you can choose to get subordinate mortgages.
If you are unable to get more than a twenty percent down payment, the lender will charge you private mortgage insurance.
To avoid the PMI, you can choose to get a small amount of loan as a subordinate lien.
If you have a very good interest rate on your first mortgage and you need money to remodel your house or pay off your high-interest debts, you can choose a subordinate mortgage to pay for the same without touching your first mortgage.
Conclusion
Though subordinate financing could be an option, remember that it is still a debt attached to your property.
If you go overhead with your debt situation you might end up foreclosing the property.
It is a big choice to make; hence, you need to ensure that you have a plan to repay with a backup plan in case your financial position does not remain consistent in the future.
Understanding the risk of getting a subordinate mortgage beforehand may help you to make an informed financial decision.
