A subordination agreement is a written agreement between two lien holders who hold liens on the same real estate. This contract may be a useful option to explore at the origination table with senior clients who have existing second liens. Since many existing second lien holders will be unfamiliar with HECM subordination requirements, this article provides guidance on the use of subordination agreements during loan origination.
When there is more than one mortgage on the property, the mortgage that was recorded first will have priority. The relative position of the mortgages is important because it gives the mortgage holder in first lien position priority in the interest of the property. For instance, assume that a homeowner has an existing first mortgage and also has an existing HELOC that was obtained and recorded after the first mortgage. If the homeowner defaults on either obligation and the respective lender initiates foreclosure proceedings, the lender in first lien position will receive payment from the foreclosure sale before the lender in the second lien position. Since there is only a limited amount of money generated from a foreclosure sale, the lower a mortgage is in priority, the less likely it will be fully paid in the event of default and foreclosure.
In certain instances, the priority of recorded mortgages can be controlled by a written agreement known as a subordination agreement. In this contract, lien holders agree on the relative priorities of their liens.
In a subordination agreement, a prior lien or mortgage holder agrees that its lien will be subordinate, or second, to a subsequently recorded mortgage. In the example provided above, if the homeowner refinances their first mortgage with a new mortgage but wants to keep their equity line open, the new mortgage will be junior to the existing home equity line because it was obtained and recorded after the equity line. Since most lenders will not agree to provide a loan unless they are guaranteed that their mortgage is in first lien position, the only way this type of transaction can work is for the homeowner to satisfy the equity line at closing or when the existing home equity lender agrees to subordinate its line of credit to the new mortgage.
In this example, if the homeowner wants to keep their equity line open, they could request a subordination agreement from their home equity lender so that the equity line will remain open but junior, or subordinate, to the new mortgage. If the subordination request is approved, the agreement will be executed by the home equity lender and recorded in the applicable land records. The subordination agreement serves to make the home equity line of credit subordinate to the newly obtained mortgage even though the new mortgage was recorded after it.
In 2006, HUD issued Mortgagee Letter 2006-20 addressing the requirements for subordinate liens under the HECM program. In this letter, HUD advised that an existing lien of record against real estate that serves as the collateral for a HECM loan is allowed to be subordinated if two conditions are met: the existing lien is subordinate and does not intervene between the first and second HECM liens; and that there are no outstanding or unpaid obligations incurred by the HECM borrower in connection with the HECM transaction. Mortgagee Letter 2006-20 was understood to mean that an existing mortgage could be subordinated to a HECM as the current mortgage existed prior to the creation of the HECM loan and was therefore not created “in connection” with the HECM transaction.
In 2009, HUD issued Mortgagee Letter 2009-49 to reiterate its existing policy regarding
subordinate liens. According to the letter, HECM regulations mandate that there shall be no outstanding or unpaid obligations, either unsecured or secured, incurred by the HECM mortgagor in connection with the HECM transaction, except in cases involving repairs to the property, and/or mortgage servicing charges. The letter also made clear that state and local court judgments, liens and federal judgments and debts are allowable subordinate liens at HECM origination.
The important language in these letters is that subordinate liens are not allowed if they are incurred by the borrower “in connection with the HECM transaction.” This language prohibits a borrower from obtaining a subordinate lien at the same time the HECM is originated. For instance, if the proceeds from the HECM loan are insufficient to pay the closing costs and to repay any existing mortgage liens, the borrower is not permitted to obtain a new mortgage during the HECM origination process to help pay those costs that will be subordinate to the HECM. However, according to HUD, “existing second liens may also be re-subordinated to third lien position behind the HECM first and second liens.” It is clear from this ruling that HECM guidelines do not require all existing second liens to be paid in full at the HECM closing. Subordination of existing second liens during HECM origination therefore may be an option in appropriate cases.If a reverse mortgage professional has a client with an existing second lien who wants to explore subordination options, the following points should be kept in mind. Recall that in the reverse mortgage context, regulations mandate that the HECM security instruments must be in first and second lien position. The reverse mortgage lender’s mortgage must be in first position and HUD’s mortgage must be in second position. The reason for the second mortgage is to secure any mortgage payments that might be made by HUD to the borrower in the event that the lender fails to make the payments under the loan agreement, or if it assigns its interests to HUD. Therefore, if an existing lien is subordinated to the HECM, it will actually be in third lien position.
Reverse professionals should understand that many existing second lien holders will have strong reservations about subordinating their lien to a reverse mortgage. Since a reverse mortgage is a negatively amortizing loan, the existing second lien holder will likely be concerned that the amount of the reverse mortgage could ultimately exceed the value of the home. The second lien holder will therefore require assurances that there is sufficient equity in the property in order to consider the subordination request. Be prepared to explain to the existing lien holder that HECM guidelines are conservative and mandate that there is sufficient equity in the property to qualify for the program. Also, be prepared to explain why HUD’s mortgage lien is required to be in second position.
Each existing second lien holder will have its own specific subordination requirements that must be met in order to approve the subordination request. A copy of a new appraisal will generally be required to show the property value. In addition, lenders will likely require copies of the loan application for the new mortgage, a preliminary HUD-1, a copy of the title report and application fees. Some lenders will prepare and issue their own subordination agreements while others will require the homeowner to furnish the agreement to the lender for review and execution. The entire process may take some time. Most lenders will not expedite subordination requests, so it makes sense to plan ahead.
Existing lenders may be unfamiliar with HECM subordination requirements and therefore careful attention should be paid to these important details. If the subordination request is approved, confirm that the subordinating lien holder submits two subordination agreements. One agreement is for the reverse mortgage lender’s lien and the second agreement addresses HUD’s mortgage lien. In the subordination agreement, the subordinating lender should acknowledge that its lien is in third lien position behind the reverse mortgage lender and HUD. The subordination agreements should show the reverse mortgage amount as no less than 150 percent of the maximum claim amount and must not place any restrictions on the reverse mortgage lender, investor, HUD or terms of the HECM. The original subordination agreements must be properly executed and recorded in the applicable land records. Copies of the recorded agreements should be kept in the HECM file.
Although it may be an uphill battle to persuade an existing second lien holder to subordinate its lien to the HECM liens, those reverse professionals who fully understand the HECM program and its subordination requirements will be better able to help their clients obtain the agreement.