Tuesday, September 6, 2011

Subordination Agreement

Subordination Agreement
An agreement whereby a holder of a prior superior mortgage agrees to subordinate or give up his or her priority position to an existing or anticipated future lien. Subordination agreements are frequently used in development projects where the seller of the land to be developed takes back a purchase-money mortgage and agrees to subordinate the mortgage or become subject to a construction loan, thereby enabling the developer/purchaser to obtain a first mortgage loan to improve the property. The subordination agreement thus alters the normal rule of giving priority to the first recorded mortgage. As a result, the construction mortgage, even though recorded after the existing purchase-money mortgage, becomes the first mortgage.

Many interim lenders refuse to lend any money in the absence of a subordination clause in all prior loans or other agreements. Thus, most presale purchase contracts for proposed condominium units have a clause subordinating the apartment purchaser’s right to buy the apartment (equitable lien) to any future interim construction mortgage given by the developer. Thus on default, the lender could wipe out the purchase contract if it wanted to do so.

A developer of leasehold property will often try to get the fee owner to subordinate the fee to a construction loan. In this situation, subordinating is really a misnomer, because one cannot subordinate the fee to a leasehold mortgage. What the fee owner is really doing is agreeing to encumber the fee. Sometimes a fee owner will partially subordinate the fee, in which case the landlord/owner is saying to the lender that in the event of foreclosure, no ground rent will be due; the owner is not risking the fee, just the ground rent.

Some states have statutes requiring specific forms and certain disclosures of subordination agreements. It might be considered the unauthorized practice of law for the broker to draft a subordination clause.

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