Written By: Frankie Lacy
Subordinate financing refers to liens that are secondary to a first lien or mortgage. They are often used in purchase transactions to assist a customer whose purchase price exceeds conforming loan amounts ($417,000) and wish to avoid jumbo pricing. Subordinate liens may also be obtained independently of a purchase transaction for a variety of purposes including home improvements, cash out, and debt consolidation.
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There are several things to consider when performing a purchase transaction that includes subordinate financing. First, do the terms and conditions of the subordinate lien fall under Fannie and Freddie’s acceptable subordinate financing guidelines? Agency’s rules strictly prohibit loans with negative amortization, balloon payment dates less than five years, pre-payment penalties, or loans that do not fully amortize under a level monthly payment plan.
Secondly, you must obtain the required documentation to deliver the loan to your investors. The mortgage note and the subordinate lien approval are basic requirements. In addition, it is critical to deliver a 1003, 1008, and AUS findings report that reflects the correct qualifying payment and LTV/CLTV/HCLTV ratios. Check your investor guidelines for any overlays regarding the minimum qualifying payment, especially if your subordinate lien is a home equity line of credit (HELOC) or a balloon.
When executing a refinance transaction that includes a subordinate lien, there are a few additional factors to consider. First and foremost, you must obtain a subordination agreement from the subordinate lien servicer. The subordination agreement must be reviewed carefully to insure there is no verbiage that could impact your company or investor’s first lien position. Also, the final terms of the first lien must be accurate on the subordination agreement; otherwise the second lienholder may render your agreement invalid. If the loan terms on your first mortgage change during the course of processing the loan, obtain an updated subordination agreement.
When processing and underwriting a refinance transaction with subordinate financing, you may hear the term “purchase-money second”. This refers to a second lien that was obtained for the express purpose of purchasing the subject property. It is a lien that would have been obtained simultaneously with the first mortgage used to purchase the property. The pay-off of purchase-money-seconds is acceptable for limited cash-out refinancing, where as non-purchase-money seconds are not. So how can you tell if you have a purchase-money second? First, review the “date opened” line on your credit report. Does this date correspond with the first mortgage “date opened”? Does it correspond with the amount of time your customer disclosed they have been living at the subject property? If you are unable to clearly identify the second mortgage or HELOC as a purchase-money second from the credit report, you may need to request a HUD-1 settlement statement from the borrower to verify purchase-money status.
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If the subordinate lien being paid off is non-purchase money second, your refinance transaction must be executed as a cash-out refinance, regardless of whether additional cash is taken out. This is a very important distinction and can render your loan unsalable if missed. Additionally, you may execute a cash-out refinance with a subordinate lien where the borrower receives cash back at the closing table whether the subordinate lien is a purchase-money second or not.
About The Author
Frankie Lacy - As an active NAMP® member and a NAMU®-CMMU designee, Ms. Frankie Lacy is a 13-year mortgage industry veteran with extensive conventional mortgage underwriting experience. Frankie is also a mortgage instructor for Mortgage Underwriter University (www.MortgageUnderwriter.org). Topics of Frankie's expertise include: Fannie Mae, Freddie Mac, USDA Rural Housing, underwriting to investor overlays, self-employed borrowers, personal and business tax return analysis, rental income, condos/co-ops/PUDs, and more. Frankie is a Davenport University graduate with a degree in Business Administration. If you're interested in becoming a writer for NAMP®, please email us at: contact@mortgageprocessor.org.
