Subordination occurs when a lender who holds a mortgage (or deed of trust) on a piece of property agrees to make their lien subordinate to another lien.
A mortgage or deed of trust is a lien placed on a property as collateral for a loan.
Usually mortgages are recorded ( first in time - first in line )
A mortgage in the first position is in a desirable position, since a foreclosure on a mortgage will wipe out all mortgages that are second, third, etc. ( junior lien holders ).
Present Condition - You have a property with a value of $125,000, the property has a first mortgage of $85,000. You would like to borrow $45,000 but as most lenders do not want to be in the second position so besides out right refusing you the loan will charge you an enormous interest rate.
Possible Resolution – Since you have had a great relationship with the first lien holder you convince them to move (subordinate) their lien to the second position allowing the lender of the $45,000 to be in the first position. You know for this to happen the first position lien holder will require some additional consideration, but that is the cost of doing business.
Subordination & Seller Financing
Seller financing requires a motivated seller, and sometimes you need to help motivate that seller. You offer to give the seller 10-15-20% down payment if they subordinate their position. You find a hard equity lender who will lend you the required (money), which will be secured by a first mortgage on the property. The seller will receive the (money) at closing, along with a promissory note and mortgage for the required sale price, which is subordinate to the first mortgage.
Using subordination on properties you already own, is a great way to get cash out of the equity you have in the property. If you purchased the property with seller financing, you work with the holder of
that note and have them subordinatetheir mortgage to a new first. You most likely will need to give the note holder some incentive, such as additional cash, pay down the principal, change the
interest rate, etc.
Substitution of Collateral is a method of moving the collateral, usually a lien from one piece of property to another. As an Exchangor you know that the substituted property does not necessarily have to be real estate. You can use the title to a car, boat, plane, etc. anything of value you agree upon as the substitute collateral.
You own an improved piece of property valued at $100,000 with a $65,000 first mortgage. You also own a free and clear vacant lot with a value of $65,000. You would like $65,000 cash, and you don't want to sell your property to purchase it, which means you will need to find a lender who will allow you to continue making payments on an unsecured promissory note, which they can sell at a discount, exchange, use as will let you borrow against the vacant lot or borrow more than $35,000 on yourproperty.
You could work with the first mortgage holder to agree to substitute the vacant lot as collateral for the mortgage. This may require giving some incentives to the note holder, paying down the mortgage, adjusting the price of the first mortgage, changing the interest rate, etc. or adding something of value.
If the note holder is motivated, you may get them to release the mortgage with no substitute of collateral. The note holder may be willing to take a discount on the amount owed on the note. The note holder may like collecting the monthly payments and doesn't want to be paid off. With a little incentive (something of value) they may agree to release the mortgage from the collateral, etc.
Substitution of Collateral or Walk the Loan
Present Condition –As an exchangor you would like to
use your property, an 8-unit apartment building and exchange into a 24 unit building. There presently is a private second mortgage of $180,000 on your 8 - unit making this a problem for the owner of the 24 unit building.
Possible Resolution –You approach the holder of the private second mortgage on your 8 unit and request he move security for the note from the 8 unit to the 24 unit building. The terms of the promissory note may remain.
Benefits to you –This will increase the equity in the 8 unit by $180,000. You may have to offer the note holder a sum of money, or rewrite the present note, but you will have a larger piece of property to work with.
Benefits to exchangor – It makes it acceptable to the owner of the 24 unit building to do the exchange.
Benefits to note holder –The positive benefit to the holder of the note is a greater and more desirable security for the loan. He may also have received a sum of money along with rewriting the present loan.
Subordination & Substitution of Collateral
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Wayne H. Wagie
The Wonderful World of Real Estate