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In general, if a debtor takes out multiple loans on a property or item, the oldest loan has priority over newer loans. If a debtor wishes to make an older loan inferior to a newer loan, the creditors associated with each loan must execute a subordination agreement. A subordination agreement is simply a legal document entered into between two or more parties who wish to change the legally established priority of loans.
Essentially, a subordination agreement has the effect of giving a junior loan priority over a senior loan. This is particularly important if an event like a foreclosure occurs because a loan that has senior status is normally paid off in full before any payments are directed to more junior debts. If several creditors have interest in a property or item, a senior creditor can agree to subordinate some, but not all, of the junior creditors.
Subordination agreements are most commonly used in mortgages to change the priority lienholders have over a piece of real estate. They can also apply to other kinds of debt interests, like leases or bank loans. In addition, these agreements are sometimes used for water rights. For example, a senior water rights holder can grant priority to a junior holder through a subordination agreement.
A mortgage subordination agreement is typically entered into between two or more lenders that have given loans on a property via a mortgage or deed of trust document. It frequently arises when the property owner has taken out a first and second mortgage and wishes to refinance the first mortgage. Before the refinancing can take place, the lender associated with the first mortgage may require the lender associated with the second mortgage to sign a subordination agreement. By singing the agreement, the second lender agrees that the refinanced loan will be the more senior loan.
If the property ultimately becomes subject to foreclosure proceedings, any recovered money would first go towards repaying the loan with the highest priority until it was fully paid. Any remaining money would then be applied to the subordinated loan. Most mortgage subordination agreements must be filed with local land records offices.
Generally, in order to be valid, a subordination agreement must be in writing and signed by the two creditors who intend to be bound by it. A debtor may also be made a party to the agreement. In some cases, a subordination arrangement is made part of a larger contract. In this situation, it’s usually referred to as a subordination clause.
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