Subordination Agreements: Who Gets Paid First?

Overview

A subordination agreement is a recorded or recorded-ready contract lenders and borrowers use to rearrange the priority of liens on the same asset. In U.S. secured lending the default rule is “first in time, first in right”: liens recorded earlier generally get paid first. A subordination agreement lets a lender voluntarily agree that its lien will be treated as junior to another lien—so the party who gets paid first can change by agreement rather than by the recording order alone (see Consumer Financial Protection Bureau: mortgage basics, https://www.consumerfinance.gov).

In my 15 years advising homeowners and small business owners, I’ve seen subordination agreements make the difference between a successful refinance and a denied loan. Lenders typically require them when a borrower wants to replace a first mortgage, take a cash‑out refinance, or preserve a HELOC while refinancing. They’re also common in commercial real estate when multiple lenders or investors have interests in the same property.

Why priority of payment matters

Lien priority affects recovery if the borrower defaults or the collateral is sold. The senior lien is paid from sale proceeds or foreclosure settlements before junior liens receive anything. Changing priority with a subordination agreement can:

• Allow a borrower to refinance a first mortgage while keeping a second mortgage or HELOC in place.
• Enable a new senior lender to take priority, facilitating new financing for business expansion or property acquisition.
• Increase risk for subordinate lenders, who may accept lower repayment prospects in exchange for fees, interest adjustments, or other protections.

Authoritative sources on mortgage and lending obligations provide background on lien priorities and title recording (see Consumer Financial Protection Bureau and local county recording office practices).

How subordination agreements work (step-by-step)

1. Identify conflicting liens: determine which mortgages, HELOCs, or security interests sit on the same collateral and the recording dates.
2. Lender request: a borrower or new lender asks an existing lienholder to subordinate its lien (often required by the new or refinancing lender). Typical requests arise during rate-and-term or cash-out refinances (see FinHelp: Refinancing 101: When to Refinance Your Loan – https://finhelp.io/glossary/refinancing-101-when-to-refinance-your-loan/).
3. Lender review: the subordinating lender reviews the borrower’s credit, property value, the new loan terms, and combined loan-to-value (CLTV). Many lenders refuse subordination if CLTV will exceed their underwriting limits (see FinHelp: Combined LTV (CLTV) and Its Effect on Refinance Eligibility – https://finhelp.io/glossary/combined-ltv-cltv-and-its-effect-on-refinance-eligibility/).
4. Negotiation: the lender may require concessions—fees, updated covenants, interest rate changes, or a deed-in-lieu clause—before signing the agreement.
5. Documentation: the subordination agreement is drafted, executed by the lender(s), borrower if required, and typically recorded with the county recorder or held in the new lender’s title binder.
6. Recording and closing: title companies usually ensure the subordination document is in place before the refinance or new loan funds.

Common situations where subordination is used

• Refinancing a primary mortgage while keeping a second mortgage or HELOC in place.
• Taking out a new senior loan for commercial property acquisition that must be senior to existing debt.
• When a construction lender requires the permanent lender to be subordinated until construction is complete (or vice versa, handled via an intercreditor agreement).

If you have a HELOC or second mortgage, lenders will often condition approval of a refinance on a signed subordination agreement so the HELOC remains junior to the new mortgage. That prevents the HELOC from accidentally becoming the senior lien after closing.

Subordination vs. intercreditor agreement: what’s the difference?

• Subordination agreement: usually a one-party concession stating that a lender’s lien will be junior in priority to another lien. It changes payment priority but may not address enforcement or workout procedures.
• Intercreditor agreement: more detailed and common in commercial financing and syndicated loans. It outlines not only priority but also enforcement rights, standstill periods, cure rights, and remedies among multiple lenders.

Commercial deals often use intercreditor agreements rather than simple subordination to handle complex default scenarios and protect senior lender interests.

Negotiation points lenders often seek

When a lender agrees to subordinate, it typically negotiates protections that may include:

• A subordination fee or amendment fee.
• Updated loan covenants or a mortgage modification.
• Agreement that the subordinate loan will be paid off in defined events (sale, refinance beyond certain CLTV levels).
• Release provisions for portions of collateral after certain proceeds or thresholds are met.

In practice I’ve negotiated reduced subordinate interest rates and small fees in exchange for timely signatures on subordination documents—simple concessions can unlock a refinance that saves the borrower hundreds monthly.

Risks for borrowers and subordinate lenders

For borrowers:

• A subordination agreement can make a refinance or new loan possible, but it increases the risk to junior creditors and may limit future borrowing if CLTV rises.
• If the borrower’s financial situation deteriorates, the subordinate lender is first to lose in a foreclosure sale.

For subordinate lenders:

• Subordination increases loss severity if foreclosure or bankruptcy occurs.
• Junior lenders may require higher interest or fees to compensate for increased risk.

These trade-offs are why lenders carefully underwrite and often require title endorsements or insurance to protect their positions.

Practical example (numbers)

• Property value: $400,000
• First mortgage: $300,000 (recorded 2018)
• HELOC: $40,000 (recorded 2019)

Borrower seeks to refinance the first mortgage for $280,000 (rate-and-term refinance). The HELOC lender must sign a subordination agreement confirming the HELOC remains junior to the new $280,000 mortgage. If the HELOC refuses, the HELOC could become senior after the refinance if its lien remains recorded as earlier (depending on recording), which could block the refinance.

Combined loan-to-value (CLTV) after refinance = (280,000 + 40,000) / 400,000 = 80%. Many lenders have maximum CLTV limits; a subordinating lender will check this before signing (see FinHelp CLTV guide: https://finhelp.io/glossary/combined-ltv-cltv-and-its-effect-on-refinance-eligibility/).

Steps to request a subordination agreement (for borrowers)

1. Contact your new or existing lender early—don’t wait until closing. Lenders need time to underwrite the request.
2. Provide documentation: current payoff information for the subordinated loan, property valuation or appraisal, and the new lender’s application package.
3. Expect review: the subordinating lender will check CLTV, credit, and the new loan’s purpose (rate-and-term vs cash-out).
4. Negotiate terms and fees if required.
5. Ensure the subordination is properly executed and that the title company has the document for closing. If recording is needed, confirm county requirements.

How subordination affects credit and taxes

• Credit reports generally do not show lien priority; they show that a loan exists. Subordination itself usually does not change a credit score. However, if subordination enables a refinance that reduces payments, positive cash flow may help credit over time. (Consumer Financial Protection Bureau, https://www.consumerfinance.gov)
• Tax consequences: subordination changes lien order, not the tax treatment of mortgage interest. Mortgage interest deduction rules are governed by the IRS (see IRS Publication 936 for mortgage interest deduction rules, https://www.irs.gov). Consult a tax professional when large changes to mortgage debt occur.

Common mistakes and red flags

• Waiting too late: requesting subordination at the last minute can delay or derail a closing.
• Not checking CLTV: many lenders will refuse to subordinate if the refinance raises CLTV beyond their limits.
• Assuming automatic approval: lenders are not obligated to subordinate; written consent is required.
• Overlooking recording rules: county recording processes vary—confirm whether the subordination must be recorded to be effective.

Frequently asked questions

Q: Will my second mortgage automatically stay in second position after I refinance the first?
A: Not necessarily. The second mortgage’s position depends on recording order and any signed subordination agreements. Lenders often require the second lender to sign a subordination agreement to guarantee it remains junior.

Q: Can a subordinated lender reverse the agreement?
A: No—once properly executed and, if required, recorded, a subordination agreement is binding. Any amendment requires a new agreement signed by the parties.

Q: Does subordination increase my interest rates?
A: Subordination itself doesn’t automatically raise rates on your loans, but subordinate lenders may negotiate higher rates or fees for the increased risk.

When to consult professionals

Always involve a title company and an attorney when negotiating or signing a subordination agreement, especially for commercial or complex transactions. In my practice, lenders’ legal departments and experienced closing attorneys often shape the final language; having counsel avoids unintended consequences.

Authoritative resources and further reading

• Consumer Financial Protection Bureau — mortgage basics and closing (https://www.consumerfinance.gov)
• Internal Revenue Service — mortgage interest deduction (Publication 936) (https://www.irs.gov)
• Investopedia — subordination agreement overview (https://www.investopedia.com/terms/s/subordination-agreement.asp)

Internal resources on FinHelp

• See our guide to refinancing for timing and practical steps: Refinancing 101: When to Refinance Your Loan (https://finhelp.io/glossary/refinancing-101-when-to-refinance-your-loan/) for decisions that commonly trigger subordination requests.
• Read on combined LTV and refinance eligibility to understand underwriting thresholds lenders check before agreeing to subordinate: Combined LTV (CLTV) and Its Effect on Refinance Eligibility (https://finhelp.io/glossary/combined-ltv-cltv-and-its-effect-on-refinance-eligibility/).

Professional disclaimer: This article is educational and not personalized financial, legal, or tax advice. Rules and policies can vary by state and lender; consult your attorney, lender, or tax advisor for guidance on your situation.