Different liens on the same property usually have priorities according to the time of their creation. To achieve the subordination of a prior lien, there must be an actual agreement to that effect.
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When you get a mortgage loan, the lender will likely include a subordination clause essentially stating that their lien will take precedence over any other liens placed on the house. A subordination clause serves to protect the lender if a homeowner defaults.
For example, assume a company has secured senior debt of $60 million and subordinate financing that totals $40 million. If a company liquidates all of its assets in a bankruptcy for $80 million, it first needs to pay off the $60 million amount of its debt held by secured lenders.
Subordination Agreement: An agreement by the holder of an encumbrance against real property to permit that claim to take an inferior position to other encumbrances against the property.
A Subordination Agreement is a legal document that establishes the priority of liens or claims against a specific asset.
Subordination agreements are used to legally establish the order in which debts are to be repaid in the event of a foreclosure or bankruptcy. In return for the agreement, the lender with the subordinated debt will be compensated in some manner for the additional risk.
There are two ways to subordinate tranches of debt so that one tranche takes priority over the other. The first is called lien subordination, in which two forms of senior, equally ranked debt share the same collateral, but one is given priority over that collateral in case of liquidation.
The new lender prepares the subordination agreement in conjunction with the subordinating lienholder. Then the parties typically sign the agreement. But in some cases, just the subordinating lender will need to sign the paperwork.
A subordination agreement prioritizes debts, ranking one behind another for purposes of collecting repayment from a debtor in the event of foreclosure or bankruptcy. A second-in-line creditor collects only when and if the priority creditor has been fully paid.
