The subordination clause, also known as the subordinate clause in real estate, finance, and banking, refers to the order of priorities in claims for ownership or assets. The subordination clause is the legal agreement that establishes the order of priorities in the form of a clause (within a contract).
A clause identifies a particular section of a real estate contract (for those of you who don’t know). There are many types of clauses in real estate, and you are likely to see many of them on your real estate exam.
What is the Subordination Clause?
Definition: The subordination clause (in real estate) establishes an order of priorities of financial claims (liens).
So what does that mean? Well, the subordination clause effectively makes the current claim number 1 to any existing claims that have already been recorded.
Usually, financial claims or liens have some form of order. Think about it. If a house forecloses, there must be a system in place for the appropriate parties to get paid. Or else, how would anyone understand who gets paid first? Well, that’s precisely what the subordination clause does; it establishes a ranking system for claims against the property. To adjust the priority of a claim, a lender usually requires a subordination clause.
Who Benefits from a Subordination Clause?
A subordination clause is meant to protect the interests of the primary lender. A primary mortgage usually covers the cost of purchasing the home; however, if there is a secondary mortgage, the clause ensures that the primary lender retains the number one priority. In other words, the primary lender’s claim will supersede any other financial claims.
Subordination clauses are commonly used when a home loan is refinanced. Refinancing results in the original home loan being paid off and a newer loan with a different interest rate being established. Theoretically, that would put the new lender at the end of the priority list, but mortgage lenders require their loans to be first in line. So to refinance a home, other claim holders have to agree before refinancing can begin.
Exceptions to the Subordination Clause
Obviously, some financial claims or liens can’t be reordered, and the appropriate parties won’t always agree to refinance.
For example, if a homeowner doesn’t pay their taxes, the IRS may put an involuntary lien on the property. If, later on, the homeowner tries to refinance, that decision will ultimately be up to the IRS. They could say yes, but again, ultimately, it’s up to them.
What to Know for the Real Estate Exam
What’s important to understand for the real estate exam is like other clauses, you need to remember what the subordination clause is.
Remember, the subordination clause establishes an order of priorities of financial claims.
A question on the exam you might see is a list of different contract clauses, and you may need to distinguish which-is-which.