I have a first mortgage and a home equity loan that I want to refinance to a new first mortgage. My lender told me that I don't have enough home equity to refinance them both, and that I have to subordinate my home equity line. What does that mean?
Try FHA for High-LTV Refinance
First, if both of your mortgages don't exceed 96.5% of your home's value, you may be able to refinance with an FHA mortgage and wipe out your home equity loan that way. But if that isn't an option, read on to learn about subordination.
Understanding the Position of the First and Second Mortgage Lenders
Right now, you have a mortgage lender in first position and your home equity lender is in second position. If you default on your mortgage, the lender in first position gets repaid first (from the proceeds of a short sale or foreclosure sale), and the lender in second position (also called the junior lien-holder) gets paid second if there's anything left. Because that's a riskier position, second mortgages carry higher interest rates than first mortgages. But what happens if you refinance your first mortgage? The second mortgage automatically moves into first position and the new mortgage ends up in second position. That's why the new lender won't grant you a mortgage unless the home equity lender agrees to subordinate, or put its loan in second position behind the new loan.
When Would You Need to Have a Second Mortgage Subordinated?
There are several reasons that homeowners would choose to subordinate a second mortgage rather than roll it into a new first mortgage.
- You have a prepayment penalty on your second mortgage.
- You have a home equity line of credit you'd like to keep open.
- You don't have enough equity to wrap both loans into a new refinance mortgage.
A good mortgage loan officer and title company should be able to take care of the subordination for you.
What Could Cause You Problems with Subordination?
To qualify for second loan subordination, many second mortgage lenders require the following:
- You need to be current on your loan payments.
- Your new loan won't increase your monthly payment beyond certain limits.
- You can't take cash out or consolidate debt with your new first mortgage.
- You may have to pay some administrative fees.
- You may be able to get payment/cash out exceptions if your financial position is strengthened (if, for example, debt consolidation drops your debt-to-income ratios) and/or your application is particularly strong (excellent credit and income).
What if the Second Mortgage Lender Won't Subordinate?
This should never happen, but unfortunately it does. There is no reason a second mortgage holder should refuse to subordinate a loan if you're in good standing and the new first mortgage puts you in a stronger position. If your balance hasn't increased (meaning that you aren't doing a cash-out refinance), and your rate and payment are lower (putting you in a stronger financial position and actually making their second mortgage less risky), there is no reason why a second mortgage lender shouldn't subordinate its loan. But unfortunately, it happens. In that case, replace it with a new second mortgage and a new lender. Get the subordination policy of the new second mortgage lender in writing so you know you can subordinate it to a new first mortgage.