How Often Will Banks Subordinate a Home Equity Loan When Refinancing the First Loan?
Lenders typically do not allow you to subordinate home equity loans or other types of debts unless you plan to refinance your first loan with the same lender that holds the equity loan. However, even if you intend to refinance your first lien with your home equity lender, you may find yourself unable to obtain a subordination agreement.
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Seniority Of Liens
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Lien holders are parties that have a claim on your home. You may have several liens on your property, since mortgage lenders, homeowners associations, creditors and government entities have the ability to place liens. When multiple liens exist, the liens are prioritized in terms of seniority. The oldest lien occupies the first lien position, and the most recently placed lien occupies the last lien position. Legally, nothing prevents a lien holder from signing a subordination agreement to allow a junior lien holder to move above it in the lien hierarchy.
Foreclosure
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If you default on your first mortgage, the first lien holder can foreclose. When this happens, the lien holder arranges to have your home sold. After the sale, the lien holder uses the sale proceeds to settle your unpaid debt. Any remaining funds are passed onto other lien holders based on the seniority of liens. If you owe $100,000 on your first mortgage and $50,000 on your home equity loan but your home sells for just $99,000, your first lender loses $1,000, and your equity loan lender loses its entire investment. Therefore, a home equity lender weakens its claim on your home if it signs a subordination agreement, and, as a result, lenders rarely agree to sign these documents.
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Home Equity Lender
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If you refinance your first lien with your home equity lender, that lender may agree to sign a subordination agreement because it would hold both the first and second lien positions. However, lenders typically sell first lien loans to government-sponsored enterprises (GSE) such a Fannie Mae but hold onto home equity loans. Your lender can make some upfront cash by writing and selling the first lien, but in the long term, the GSE that buys the first lien has the senior claim on the home rather than the home equity lender. Therefore, lenders usually only subordinate second liens if the lender plans to hold onto the new first lien rather than sell it.
Considerations
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Generally, lenders refuse to enter into subordination agreements, but if your home's value greatly exceeds the combined balances of the first mortgage and the equity loan, your lender has little chance of losing money if you go into foreclosure. Furthermore, if your lender refuses to subordinate the loan, you might decide just to pay off both loans with a refinance mortgage. If you pay off the equity loan, the equity lender loses a monthly source of income. Faced with losing a reliable borrower to a competitor, some lenders may agree to subordinate your loan.
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