A large amount of equity in your home may prompt you to take out a home-equity line of credit. Lower interest rates could also motivate you to refinance an existing mortgage or mortgages. A subordinate clause in a second or third mortgage gives the first mortgage priority. This means that if the house is sold, the debt owed under the primary mortgage gets paid off first. If a foreclosure occurs, the lenders of the other mortgages might not be paid, unless the sale proceeds exceed the balance of the first loan.
A subordinate clause in a mortgage states that all original claims on a debt must be paid before any new ones.
Purpose of a Subordinate Clause
A subordinate clause is meant to protect the interests of your primary lender. Your primary, or first, mortgage usually covers the cost of purchasing the home. The primary lender stands to lose the most if you default on the loan. Since a mortgage is a claim against the property, a subordinate clause ensures that the primary lender retains first position rights. In other words, the primary lender's lien against the property supersedes any other mortgages or claims.
Home-equity lines of credit help you take advantage of your home's market value. A home-equity line of credit is an example of a second mortgage. For instance, if your primary mortgage balance is $50,000 on a $150,000 home, you could borrow up to $100,000 in equity. Simply put, a second mortgage is an additional lien against your home that remains separate from the first. Unlike first mortgages, a second mortgage usually is not re-sold to another lender. A second mortgage could become a first mortgage if the primary loan is paid off during its term.
Some homeowners already have two mortgages and wish to refinance the primary loan. In this scenario, the original subordinate clause moves the second mortgage into first place. This happens since the original primary loan will no longer exist. A lender may not approve a refinance until the second mortgage's lender agrees to another subordinate clause. The clause moves the second mortgage back behind the refinanced loan. A refinance that combines two or more mortgages into one loan will not require a subordinate clause.
Lenders can have different subordination policies. When you're shopping for a second mortgage or home equity line of credit, it is wise to review the lender's subordination policy. Some banks may not allow it at all, while others will agree to a subordination clause only as long as you do not refinance the primary mortgage. A lender might have a subordination policy that allows a refinance if the balance of the primary mortgage does not increase.
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