The home equity loan or HELOC usually has a higher interest rate than the first mortgage because there is a greater risk that the owner will default, or a greater chance of foreclosure. If the home goes into foreclosure, the lender that holds the first mortgage will get paid first since it is the senior debt. The lender that holds the HELOC will get paid with what’s left over, since it is the subordinated debt. In some cases, there may be nothing left at all to collect. Loan subordination is often detailed in a subordination agreement or clause. The purpose of a subordination agreement in a mortgage is to protect the primary lender on the home. This is most often the bank or financial institution that holds the first mortgage. That institution stands to lose the most in the case of default or foreclosure. The subordination clause protects this first lender, and simply assures that the first mortgage holder will be paid if the home goes into foreclosure. Since being second in line to collect debt carries more risk, lenders may take extra measures to protect their end of the bargain, such as:
There will be charges or other fees to pay to cover administrative costs.You must be in good standing with your lenders on all of your payments.There are limits set on the amount of your total monthly mortgage payments.
Senior Debt vs. Subordinated Debt
Senior debt is the primary debt, and since it is more often secured with collateral, it’s less of a risk for a lender than subordinated debt, which is often unsecured.
Refinancing and Resubordination
If you have a first mortgage plus a HELOC and you want to refinance, then you have to go through the resubordination process. Resubordination is often shortened to just “subordination.” Refinancing is when you take out a new loan, with new terms, and use it to pay off the first loan. It wipes out the old mortgage and puts a new first mortgage in its place. Because the original mortgage loan is no longer there, the HELOC moves into the primary or senior debt position—unless there is a resubordination agreement in place. The lender that holds the HELOC has to agree that its loan will be second in line with the new first mortgage loan through a resubordination agreement.
What Subordinated Debt Means for You
If you wish to refinance your home and you have a HELOC in place, your new lender will insist that the HELOC be resubordinated. The lender of the HELOC that you already have is not required to do this, but most do. If that lender does not agree to fall second in line, you may have to wait and try again once you’ve built up more equity in your home. The state of the housing market may also factor in the lender’s decision. The lender of the HELOC is going to look at the loan-to-value ratio of both the new first mortgage and the mortgage it holds, combined. If home values are rising, this is less of a problem. If they are falling, this could cause you to hit a bump in the road. If you have any problems resubordinating your current HELOC, you can try refinancing that loan. Refinancing a second mortgage can be easier than refinancing a primary mortgage.
