Subordination Agreement Definition
A Subordination Agreement is a legal document that confirms that a debt is higher in rank (takes precedence) over another debt as touching debt repayment. It is a form of arrangement of debt priority in terms of collection, in which a debt is established to be prior to another in terms of collection.
A subordination agreement is mostly used in situations where a debtor defaults or enters bankruptcy. When a subordination agreement is in place, a party’s claim is superior to the other party, hence, the assets of the borrower is placed under a lien or sold to repay the debts.
A Little More on What is a Subordination Agreement
Generally, lenders and financial institutions attend to the needs of individuals and businesses who are in dire need of funding. They do this by offering debt otherwise called loans. When a person or a business borrows money, interest is paid on the borrowed amount as a compensation for the lender. However, in cases where the borrower is in default of bankruptcy, the lender can seek a subordination agreement in order to secure repayment for the debt and to guarantee repayment should the borrower use the same property to take another loan.
In a subordination agreement, the second loan is ranked lower and regarded as ‘junior’ debt. Hence, it becomes a subordinated debt, which means the first lender gets repayment before the second lender does.
A subordination agreement indicates that the lender of the senior debt has the legal right to be repaid in full before the lender of the second dent. The senior lender also has a higher claim to the property or asset. This type of agreement is mostly used if a debtor is in default or has insufficient money to settle the debts of the first lender.
Here is an example of a subordination agreement
If Mr A takes a loan of $500,000 from Lender A in January and proceeds to Lender B to take a loan of $350,000 in September, the first loan is the senior debt while the second is the junior debt. If the individual enters defaults and his assets or properties are sold to make repayments for the loan, the senior debt will be settled first. This is if the money realized from the foreclosure and sale is $700,000, Lander A would be paid $500,000 in full before Lender B receives any repayment. This means the second loan is subordinated debt which carries more risks that the senior debt with higher priority.
- A Subordination agreement is a legal document that ranks a debt as senior and the other junior for the purpose of collecting repayment from a borrower.
- A senior debt is ranked higher and is accorded much priority in terms of repayment.
- A Subordination agreement is often used when more than one loan is attached to a single asset or property.
- A subordinated debt has more risks because the senior debt is repaid in full before it is settled.
- Subordinated debt lenders have higher interest rates to compensate them for the risks.
Types of Subordination Agreements
There are many types of Subordination agreements. This type of agreement is mostly used when multiple mortgages or loans are pitched against the same asset or property. This form of agreement is a feature of complex corporate debt structures.
For instance, an unsecured loan with is issues without any collateral is subordinate to a secured loan which is collateralized. Subordination agreement can also occur in mortgages.
Subordination agreements are widely used in the mortgage sector, this is because in the mortgage industry, an individual can take multiple loans (mortgage) with the same asset. In subordination agreements, the first mortgage has the highest priority over all other mortgages. A borrower can however upset the order or priority by refininacu the original loan, that is, paying the first loan and receiving a lew loan. Since the second lender still remains the lender of the junior debt, a lender of the first mortgage that is being refinanced will seek a subordination agreement in order to maintain its position as the highest ranking in terms of debt repayment. The subordination agreement must be signed by the second mortgage lender and acknowledged by a notary.