Subordination Clause

It refers to the order of priority in claims for ownership or assets, also called a subordinate clause or subordination clause in real estate, banking, and finance. As a clause (within a contract), the subordination clause determines the order of priority. (Those of you who don’t know what clauses are) A clause denotes the specific section of a real estate contract. You will probably see many types of clauses on your real estate exam since there are many types of real estate clauses.

Lenders must take several risks when they issue mortgages. A variety of financial issues can arise quickly in the real estate market as property transfers, liens, and other matters can occur at any time. A subordination clause in real estate can protect their financial interests by ensuring their repayment rights take precedence over other agreements.

Subordination clause in real estate

As part of a real estate contract, subordination clauses specify that current debt claims will take precedence over future ones. Subordination refers to deferring priority from one party to another. A mortgage note or commercial real estate agreement typically uses them.

Liens are generally subordinated to real estate subordination clauses in contracts. One party receives priority, which is passed along to the next party. In addition to signing subordination clauses with your other agreements, you can adjust a lien’s focus. Subordination clauses can be complicated. States and the federal government have regulations governing their use. Before incorporating them into your strategy, you should seek legal advice because they can also be mighty when appropriately used.

Your mortgage note’s subordination clause specifies the conditions around the mortgage agreement that state the lender’s lien takes precedence over any other liens on your property. You must remember that first-lien holders receive repayment first in the event of default.

It is usually the primary lender who receives priority in most cases. To help you better understand subordination clauses in mortgage notes, here is an example:

  • John decides to buy a property.
  • The bank that John’s bank borrows money from agrees to prioritize repayment when John purchases a home.
  • The bank secures its rights with a subordination clause.
  • After three years, John defaults on several credit cards.
  • His credit card companies filed a successful civil claim for repayment against John.
  • A lien was placed on his house by the civil court.
  • John’s lien must be repaid to the lender before paying the creditors according to the subordination clause.

Clauses in commercial leases relating to subordination

Commercial lease agreements contain subordination clauses that specify the priority of the lease over the mortgage. The tenant will face severe business disruption if the owner of the commercial property defaults on the mortgage. Lenders have the right to evict tenants at will if the lease is subordinate and second to the mortgage. For example:

  • XYZ Corporation is the landlord of ABC Company’s property.
  • The lease XYZ Corporation signed stipulates that it is second in priority to the mortgage at lease signing.
  • XYZ Corporation still pays its mortgage to the bank.
  • The bank repossesses the property after XYZ Corporation defaults on its mortgage after one year.
  • Given the second priority status of the lease, the bank terminated it.
  • So ABC Company would have to find a new location.

Keep in mind that the lender has a vested interest in commercial lease properties. A vacant, non-mortgaged property can therefore be rented out for money. Lenders may, however, lack the resources for engaging in this type of relationship so that outcomes may differ.

Legal document

A subordination clause is a legal document that says that any claim on debts that may arise shortly will take precedence over any other claim. In simple terms, a subordination clause effectively gives one debt priority over another, thereby securing the status of the primary lender as the primary payer, superseding any other mortgages or claims. One of the most important things to notice is that subordination agreements change the lien position.

Benefits of a subordination clause in real estate

The lender is the primary beneficiary of a subordination clause in real estate. However, a subordination clause gives the first lender priority in repayment and contract rights if you decide to take out a second mortgage. When refinancing a property, subordination clauses are most commonly used. When a loan is refinanced, the original loan is fully repaid, and a new loan provider structures the agreement based on a new interest rate. Subordination clauses ensure that a new lender is first in line for repayment rather than at the end of the priority list.

Read More: What Is An Encumbrance In Real Estate? Everything You Need To Know About Encumbrance

Getting legal help with subordination clauses

The laws surrounding subordination clauses for real estate can be complex. A legal professional should be consulted about several considerations and nuances. Consult a real estate lawyer for advice and guidance if you need subordination clauses in real estate. Get started on Contracts Counsel now.

Exceptions

Some claims or liens can’t be reordered, and there will not always be an agreement to refinance. The IRS can place an involuntary lien on a property if a homeowner fails to pay their taxes. The IRS will ultimately decide whether the homeowner can refinance later on. In the end, it’s their choice whether or not to say yes.

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