Subordinate financing is any other mortgage that you take out to finance a home purchase or pull a home equity. The debt ranks second to the first mortgage or senior mortgage. If you purchase a home using a first mortgage, other additional mortgages are called subordination or subordinate financing.
In an 80/20 mortgage, for example, the 80% is the first mortgage while the 20% is the subordinate or second mortgage.
Many home buyers use a subordinate financing to eliminate the need to pay for a down payment.
Subordinate Financing Risk to Lenders
Seniority matters in mortgages. This means the lender who provided the senior or the first mortgage will have first claim on repayments in the event of a non-payment of the loan or a foreclosure.
Whatever amount is left will go to the provider of the subordinate mortgage.
If the proceeds of a sale amounted to $200,000 and the first and second mortgages are at $180,000 dollars and $35,000, respectively, the subordinate financer will be $15,000 short on repayments.
Subordinate Financing Disadvantages to Buyers
- Interest rates of subordinate financing tend to be higher than those imposed on first mortgages.
- There can be two sets of discount points, loan fees, and other costs. This also means two separate checks would have to be written every month.
- The combined monthly payment is higher compared to the payment of a single mortgage loan.
- The minimum required credit score to obtain subordinate financing is at least 700.