Real-life examples: successful closing.

A Borrower requested a subordination of an existing lien in a seller carry-back transaction..

The Borrower and the first lien holder were advised that creating an inter-creditor agreement was the best option for providing subordination and a mutual understanding of the contract’s terms.

A seller’s carry-back first lien would be paid off on a refinance, but there was insufficient equity to pay off the first lien.  The seller agreed to accept a paydown of the net proceeds of the new first and carry a small second for the remainder.

The pivotal moment was the signing and recording of the subordination agreement by the first and subordinate lien holders.  This agreement and the inter-creditor agreement outline the rights and responsibilities of the parties in the event of a Borrower's default.  Its significance cannot be overstated, as it played a crucial role in the successful completion of the transaction.

Article:

Understanding the Basics: What is the Subordination of a Lien?

Subordinate liens mean a lien is, or will be placed, in a lower position, rank, or junior to the senior lienholder(s).  The junior lender is subordinate to the senior lender unless a written agreement states otherwise.

Loan documents are recorded at the municipal recorder’s office using a sequential date and time stamp method.  Any lien with an earlier recording date and time stamp has a senior priority unless the parties agree otherwise.  Ometimes, keeping the lender’s lien on the property is desirable or necessary;  however,  to agree to modify or lower its priority, a subordination agreement is a method.

When the lender prepares the subordination agreement for the Borrower and potentially senior and subordinate lenders to sign, it’s a moment of reassurance.  All parties agree that the lien priority will change or be transferred to a subordinate (lesser) or junior position, ensuring a smooth and secure transaction and instilling confidence in the process.

There are many reasons for the subordination of liens between the parties.

Reasons include:

• The transaction is an installment sale in real estate and tax planning.  A seller’s carry-back financing lender (beneficiary) may choose to defer receiving the principal from the property sale for tax-deferral purposes.  The reasoning is to extend the payment schedule, including principal reductions and interest, for a specified period.  Since a seller pays capital gains on the principal received and ordinary income on the interest earned, a subordinated lien is a vehicle for deferring tax payments, provided it is drawn correctly, offering significant benefits in tax planning.
• During a refinance process, a lender may find that the property equity is insufficient to refinance and pay off all the underlying liens and encumbrances.  In such cases, the transaction can only proceed if one or more existing lien holders (lenders) agree to take a partial principal paydown and subordinate a portion of their loan. This is where the subordination agreement comes into play, making the transaction feasible.

What is an Inter-creditor agreement (ICA)?

An Inter-creditor agreement is a written legal contract that is a signed and acknowledged document of mutual understanding between two or more lenders (usually two lenders/creditors, a first and second lien holder. The agreement provides a secure framework for resolving disputes fairly between creditors and ensuring their respective rights are protected. The contract clearly outlines the priority of the liens and how the responsibilities of parties with competing security interests are addressed when they hold separate and unequal lien positions in the event of the Borrower's default, ensuring that everyone’s rights and obligations are clear and protected.

This highlights the importance of caution and awareness in lending situations, promoting informed decision-making.

An inter-creditor agreement defines in writing who is responsible for loan payments, property insurance, property taxes, and association dues in the event of a Borrower's default.  The subordinate lender (junior) must write checks for all these expenses to protect its interest. At the same time, the subordinate lender can initiate its foreclosure procedure while keeping the first lien current for a specified period.

Intercreditor and Subordination Agreement: The document is combined.

THIS INTERCREDITOR AND SUBORDINATION AGREEMENT (thi““Agreement”) is made as of __________, by and among __________________, having an address at ____________________________ (such entity, together with any subsequent holder of the First Mortgage Loan Documents (hereinafter defined), the “First Mortgagee”), ________________________________, having an address at _______________ (such entity, together with any subsequent holder of the Subordinate Mortgage Loan Documents (hereinafter defined), the “Subordinate Mortgagee”) and _____________________, having an address at _________________(“Borrower”).

Then, the definitions, explanations of lien priorities, standstill agreements, turnover of improper payments, cure rights, representations, and miscellaneous provisions are included in the agreement.  The first lien holder, the subordinate lien holder, and the Borrower will sign the document.

If you need a blank copy of this agreement, please email me at dan@danharkey.com with this request.

The Loan Broker stated.

My client is in the process of refinancing their seller carry-back first lien financing.  The property has increased only marginally, so the protective equity is insufficient to take the first li.  The property was appraised at $970,000 with a first lien of $750,000.. The new lender will only loan 70% of the value, or $679,000. That leaves a shortfall of $71,000, or approximately $ 100,000 after accounting for costs and fees.  The seller’s carry-back principal was reluctant to allow a portion of their lien to be subordinated to a second lien position.  However, the advantages were explained by providing additional protections for an inter-creditor agreement.

The agreement provided that, in the event of the Borrower's default, the junior $100,000 lien holder could bring the property to court and initiate their foreclosure proceedings. The second was to receive a notice and 30 days to get the first current.

All parties involved in this well-structured arrangement reaped significant benefits.  The seller’s carry-back principal received a substantial principal payoff and continued to receive monthly interest payments on the remainder.  Simultaneously, the junior lien holder was assured of their rights in the event of a default, ensuring a fair and secure transaction for all parties.