The real estate lending business is full of factual representations from borrowers and mortgage brokers, but some of these “facts” turn out to be nothing but myths. The underlying question is whether some of these misrepresentations are out of ignorance, or intentional? A seasoned processor or underwriter is best to practice healthy skepticism. Good judgement comes from experience, bad judgement comes from lack of experience and making bad decisions. The loan underwriter and processing staff has the task to discover the truth and respond accordingly. The truth will either complete or kill a pending transaction.
Income real estate ownership is characterized by the expectation of an income stream. Usually the purchase of an ownership comes with financing. When an owner finances the property, a lien is recorded by the lender to secure the interest. A lien is a legal right, usually referred to as a security interest, in real or personal property given to a creditor to hold and possess as consideration for a loan. The creditor or lender has a charging interest against the collateral and may seek possession in the event of default by the borrower. A borrower willfully grants the security interest in a real property by agreeing to sign instruments called a deed of trust or a mortgage which are recorded in public records as an encumbrance to the real property in consideration for the loan. A lien refers to a monetary claim which may be attached to one or more properties.
Lien priority is related to the point of time that the document is recorded in the public records office. When a document is recorded it is date stamped and given a sequential recording reference number. If a borrower or their title company recorded 3 liens at the same time on one property, that would create a first, second, and third lien, regardless of the dollar amount of each lien. The first lien is considered a senior lien, the second and third liens are junior liens. With the second lien being senior to the third. After the documents are recorded and added into the public records database, the borrower will receive the original documents back for safe keeping.
What insures the order of the recording? How do you know that the recorder did not make a mistake and record the documents out of order? You may order and pay for an insurance policy referred to as title insurance. The policy guarantees your lien priority position or may be subjected to a title insurance claim. If you were to go to the recorder’s office, stand in line, and have the documents recorded you could check the sequence of recording for yourself. Generally, your recording of documents is done by a title company in relation to a sale or loan transaction in which you are a principal party.
What does this all have to do with subordination? The documents are recorded in a “sequential date and time stamped method”. In many cases it may be desirable or necessary to keep a lien on the property, even though another lien is recorded after the original. This is done by the using of a subordination agreement. The agreement approved and signed by the original lender or beneficiaries, and the trustor or borrowers will allow the lien priority to be transferred to a subordinate or junior position.
There are many reasons for subordination of a document to be completed.
Seller carry back lender or beneficiary’s desire not to be fully paid off the tax deferral for cash flow reasons.
The equity may be insufficient to be able to refinance and pay off all the underlying liens and encumbrances. The transaction will only work if one or more lenders agree to subordinate all or a portion of their loan, and possibly take a partial pay-down.
Certain encumbrances may need to be recorded but are adequately protected even in a subordinate lien position.Examples are:a. Subordination, attornment and non-disturbance agreement.b. Subordination of a leasehold estate.c. Subordination and intercreditor agreement.
Why is this information important? If a borrower or mortgage broker misrepresents that a lender will agree to subordinate, and you discover later that the lender refuses or never agreed in the first place to subordinate, you may have wasted a ton of time.
When the question of a lender agreeing to subordinate comes up, the very first job of the processor or underwriter is to contact the lender and verify in writing that they agree to subordinate under preconditions. The number of times that someone has promised me one thing, then changes the story would be characterized as a broken record syndrome. The way to avoid the back and forth and not waste time is to verify the truth on the front end of your transaction. Start the transaction by requesting all intended agreements be in black and white usually through a clarification email memorialized by a formal subordination agreement.
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