How subordinating second mortgages works

Oftentimes, a borrower asks if an existing Home Equity Line of Credit (HELOC) or other form of second mortgage can be kept in place even though the client is obtaining a new first mortgage. The answer, in many cases, is yes.

Whenever an existing second mortgage is left in place behind a new first mortgage, the process is called the subordination of an existing lien. Lender B, who owns the second mortgage, must agree in writing to let a new loan go in front of it. Lender A, who will be lending the money for the new first mortgage, must also agree to this subordination. Both lenders have certain criteria by which they make their decisions, and the homeowner should understand those terms and conditions before proceeding with a refinance.

In most instances, Lender A's rules for subordination are the simplest. First mortgage holders typically want to limit the combined loan-to-value (CLTV) to 90 percent or 95 percent. If your home is worth $600,000 and the existing second mortgage has a balance of $90,000, the new first mortgage may be limited to $450,000 or $480,000. Rarely will a new first mortgage allow 100 percent financing. (Note: in some cases, Lender A may not allow any secondary financing at all.) You will be required to forward a copy of the second mortgage note to Lender A, who wants to make sure it is not an open-ended note that would allow you to borrow more than 90 percent or 95 percent of the new appraised value.

Lender B will always be more particular since their equity position is in the most jeopardy. Just because you've been paying on your mortgages in a timely fashion does not guarantee they will automatically allow you to refinance the first mortgage. The following are some basic rules imposed by many lenders in second position.

First, the borrowers must be current on all existing mortgages on the subject property. In fact, many subordination agreements demand that the borrower be current on all real estate loans, including loans on investor and commercial properties. Some subordination agreements insist that there be no mortgage late payments of any kind in the last 12 months.

Secondly, the monthly payment on the proposed new first mortgage cannot exceed the payment on the existing first mortgage. This requirement can often be waived if the borrower can prove their income has gone up substantially since the original second mortgage had been approved.

Thirdly, the new first mortgage should bear a fixed interest rate, at least for the first few years. If the proposed new first mortgage is an ARM (adjustable rate mortgage), the payments could skyrocket over time and would violate the rule stated in the preceding paragraph. And if the proposed new first mortgage had the potential for negative amortization (as with many ARMs with very low teaser start rates), the equity position of the second mortgage could quickly deteriorate. These types of loans are rarely allowed in a subordination request.

Finally, the second mortgage holder will want to review the new appraisal, the preliminary title report, and the new first mortgage loan application of the borrowers. Lender B wants to be doubly sure his equity position is not being endangered and the borrower still has the capacity to make monthly mortgage payments.

Most holders of second mortgages will only entertain a subordination request if the borrower fills out the lender's specific Subordination Request Form. In addition, there is oftentimes a non-refundable up-front fee that ranges from $100 to $250 and it must accompany the subordination request. This fee is not returnable even if the request is ultimately denied.

If you are considering applying for a new first mortgage, and wish to subordinate your existing second mortgage, you should discuss this with an experienced loan officer. There are many competent loan officers out there that can guide you towards new first mortgages that may work in your situation. Also, they will assist you in contacting the holder of your second mortgage and obtaining their Subordination Request Form as well as a summary of the terms and conditions under which they will allow their loan to be subordinated.

What are people saying about mortgages today:

Rates on 30-year mortgages edged down last week to a seven-month low. Mortgage-giant Freddie Mac reported Thursday that 30-year, fixed-rate mortgages fell to 6.3 percent, down slightly from 6.31 percent two weeks ago. It put rates at the lowest level since they were at 6.24 percent the first week of March.

Bank of Hawaii, Central Pacific Bank, Territorial Savings Bank and Wells Fargo Home Mortgages all cut their 30-year mortgage rates to 5.75 percent this week.

Most people think of a mortgage as a means to an end. After all, you buy a house, not a home loan. But a mortgage is much more than the path to homeownership. It is a financial instrument that must be managed, just like any other financial investment.