There may come a time in your life where you decide to take out a loan. Borrowing money comes in many forms. Student loans, mortgages, and auto loans are just the tip of the proverbial iceberg. In some occasions, a borrower may struggle to pay back money borrowed. If that is the case, a subordination agreement may come into play. Whether you are a borrower or a lender, it is important to know the ins and outs of how loans work. Read on to find out everything you need to know about loans and subordination agreements.
What is a Subordination Agreement?
Every now and again when someone takes out a loan, they default on their payments. Translation: they fiscally cannot pay back their loan. In modern-day terms, you may call this “ghosting” on your loan payments. In some cases, these outstanding loans are one of many loans held by a specific person. What that happens, the lenders of each loan are ranked in a legal document called a subordination agreement. This document details the order in which the lenders will be paid back. In these type of situations, the debtor may have to file for bankruptcy and liquidate their assets in order to pay their outstanding debts.
What is Subordination?
To further understand a subordination agreement document, let’s break down what the process of subordination is. Subordination is the process in which creditors are placed in order of importance to be paid back.
Let’s say a debtor has three creditors. For the sake of this example, let’s call these creditors A, B, and C. If “A” is the primary creditor, they will get paid back first. Lenders B and C, on the other hand, are subordinates. B and C will only be paid back when A is back in full.
Before we dive any deeper into the mechanics of subordination agreements, lets back up a few steps and talk about loans. A loan is a financial agreement in which a person or business borrows money from an establishment with the expectation that they will pay it back over time, plus interest. Loan agreements take many forms. A blossoming small business may borrow money from a bank to open a second location. Or even more simply, a person may borrow money from a family member to help finance the advancement of their education. Let’s discuss a few of these terms in more detail.
Lender vs. Borrower
A loan is a basic example of a give and take relationship. A borrower is an entity that is requesting money. Borrowers can be a single person or represent an entire company or establishment.
On the “give” side of the equation is the lender. Sometimes referred to as a creditor, the lender is the person or establishment providing the money for the loan. As with the borrower, the lender can be a single person or a big business. Your Grandpa Joe can be your creditor just like a big bank can, but maybe with slightly shallower pockets.
What is Interest?
When a lender provides a borrower with money, they look at it as an investment. Therefore, they hope and expect to make some money off of the exchange. The terms of the loan will typically define a payment plan broken down in installments, plus interest. Interest is essentially the cost of borrowing money. Interest rate is a percentage of the amount loaned that is paid on top of the money borrowed.
Let’s say you borrow $1,000 with an interest rate of 5%. If you pay your creditor back all at once you would pay them $1,050. Additionally, your loan may allow you to pay in monthly installments of $100/month. That $100 is paying off the principle, or the original amount borrowed. Once interest is in the mix, your monthly payment would amount to $105.
Subordination Agreement: The Mechanics of It All
Now that we have deconstructed the basics of a loan, let’s discuss how subordination agreements work. First of all, subordination agreements are usually prompted by the creditor themselves. This is an added layer of protection on their investment. That is to say, these agreements are a sort of insurance on investments. The agreement will detail the terms of the loan and ensure the creditor will boast primary repayment benefits. Subordination agreements require notarization to be valid.
Subordination agreements are utilized in real estate transactions. For example, when someone takes out a loan to purchase a house, they typically enter into a mortgage agreement. It is incredibly common for people to take out a second mortgage on a home or property. This decision may be purely opportunity based, perhaps another bank is offering a lower interest rate on mortgages. Sometimes, the choice is more need-based, due to financial hardships making consistent payments. Whatever the reason, banks know borrowers often seek the aid of a secondary loan. Therefore, many mortgage creditors require their clients to sign a subordination agreement.
When a new creditor joins the party, they should be informed that they are not the first to arrive. Lending to a borrower with existing loans is a risky move for creditors. The likelihood of getting paid back is reduced when a lender owes on multiple loans. However, as the saying goes, the higher the risk the higher the reward. Secondary lenders will charge a higher interest rate, to cover the risk involved in making the loan.
However, it should be noted that secondary, or subordinate, lenders often times do not get paid back at all. You can see why this is a risky move for creditors.
Types of Subordination Agreements
Subordination agreements are frequently used in mortgage and real estate loans. However, subordination agreements have also been used in corporate debt structures as well.
Namely, these type of agreements are in reference to secured and unsecured bonds.
- Secured Bond – When a bond is considered “secured” the bond-holder with pledge an asset as collateral. An asset is anything of value (cars, property, money) that a person or business owns. Collateral is when a borrower uses their assets to secure a loan. If a borrower defaults this type of agreement, the creditor can seize the asset(s) pledged as collateral
- Unsecured Bond – On the other hand, unsecured loans are not secured by the promise of collateral. Naturally, unsecured loans and bonds are riskier investments for creditors. Cell phone bills, utility and medical bills, and credit cards are all examples of unsecured loans
In terms of corporate subordination agreements, secured bonds are the primary beneficially. Conversely, unsecured bonds are subordinate. Therefore, unsecured bonds are paid back after secured bonds.
Subordination Agreement Example
Since real estate subordination agreements are the most common, let’s use a mortgage deal as an example. Let’s say a person owes $260,000 on their primary mortgage (also known as “senior debt”). Additionally, they take out a second mortgage (aka subordinate loan) in which they still owe $95,000. Financial distress leads to defaulted payments and having to file for bankruptcy. When their assets are liquidated the debtor has a cash value of $290,000.
First, the primary mortgage of $260,000 will be paid off in full. This leaves only $30,000 left to pay secondary loans. Meaning, the subordinate lender will lose $65,000 of their original $95,000 amount loaned. This is a particularly dire example, but often times subordinate lenders will only make 50 cents on the dollar back.
If someone has multiple subordinate lenders, the remaining $30,000 would be equally distributed amongst them.
Bonus Loan Terms
In order to better understand loans and subordinate agreements, it is helpful to learn a few bonus terms. Specifically, we are going to go over three terms: lienholder, refinancing, and postponement.
Anytime you borrow money to purchase a specific item (house, car, etc), the creditor is also considered a lienholder. This means that legally, they own the property until you pay back the loan in full. A lienholder can be anyone who provides money for the loan. Individuals, big financial institutions, and private banks can all be lienholders.
As discussed, subordination agreements are commonly used regarding property loans and mortgages. When someone takes out an additional mortgage, they are likely doing so to help pay off the original mortgage or get a lower interest rate. This is called refinancing. When you refinance a mortgage, the new loan will actively pay off your original loan. The idea is that you have made a significant dent on paying the original mortgage already. That way, you are borrowing less than before, which will likely come with a lower interest rate and help you save some money on your original mortgage.
To continue rolling with examples related to mortgages, let’s talk about postponements. When a borrower defaults on a mortgage, there is a possibility of foreclosure. This process is long and expensive. Foreclosure is a detriment to both the borrower and the lender. If foreclosure is a looming possibility, a postponement may be a positive alternative.
Simply put, the lender will work with the borrower to reassess the terms of the original loan. Most likely, they will push back the due dates, giving the borrower more time to pay the loan back. This keeps the borrower from a credit nightmare and saves the lender countless dollars in legal fees involved in foreclosures. Better yet, the lender will also stand to make more money on the higher interest rates they can now charge.
Subordination Agreement Template
There are countless subordination agreement templates available online. Most leave cavities for you to fill in with specific information like the date, details of the loan, and space for a notary public to sign and stamp the document.
Keep in mind that subordination agreements are complex legal documents. Therefore, you may want to consider having your attorney look it over before you sign it.
What’s the Deal with Notarization?
As previously mentioned, subordination agreements need to be notarized to be legally binding. If you are unfamiliar with this term, a notarization is a vital form of fraud deterrent. A person called a notary public will the identity of a signer, as well as the authenticity of the document they are signing.
What Happens During a Notarization?
While notarizations are relatively simple acts, they help legitimize documents and prevent fraud. Below are the five steps to getting a document notarized.
1. Physically Visiting a Notary
First of all, it is vital to understand that notarization is a person-to-person exchange. Therefore, it is vital to physically visit a notary in person. With the constant growth of the digital world, more and more business is taking to the internet. However, almost every state in America still requires notarizations to take place in the physical presence of a certified notary public.
Currently, only five states currently allow virtual notarizations: Texas, Virginia, Montana, Minnesota, and Nevada. However, in-person notarizations are more effective at protecting you from liability and fraud.
2. Check the Document
Every state has different laws regarding certain aspects of the document itself during a notarization. For example, some states require no field be left blank in documents getting notarized. On the other hand, some states allow blank spaces. It is important to educate yourself on your state-specific notary laws and requirements. No matter what, it is a good idea to visit a notary with a completed document. However, do not sign the document until in the physical presence of a notary.
A notary is mainly going to check that the name on your identification matches the name on the document.
Notary Public vs. Lawyer
Let’s take a quick pause to discuss the role of a notary public in your document. It is vital to understand that a notary is not a legal representative. They are not there to double check the legalese of your document. Furthermore, notaries are not allowed to legally consult, draft, or advise you regarding the contents of your document.
If you have any questions regarding the content of the document you are getting notarized, be sure to chat with your attorney first.
3. Confirmation of Identity
Accurately identifying signers is the cornerstone of a successful notarization. When visiting a notary, it is vital to bring along a valid form of acceptable photo identification. The most widely accepted forms of identification are a driver’s license or passport. Certain states may also accept state-issued i.d. cards or military identification cards. Birth certificates, social security cards, and credit cards are not acceptable forms of identification.
Moreover, proper identification means more than simply comparing a face and name to an i.d. card. In fact, correctly identifying someone also calls for confirmation of consent and understanding. When you visit a notary, they will ask you if you are choosing to sign the document by choice and at your own free will. Furthermore, they will ensure that you understand the contents of the document in full.
4. Notary Journal Entry
Journals are for more than logging the details of adolescent crushes. In fact, notary journals are a valued tool of the trade. Notary journals provide an added layer of protection in notarizations.
Specific details kept in a notaries journal may vary by state. Common notary journal entries include:
- Date, time, and location of the notarization
- Type of notarization (Jurat or Acknowdgement)
- The type of document Notarized (Property Deed, Subordination Agreement, Mortgage, etc)
- Name and address of all document signers
- Forms of I.D. used to identify each signer
- Price of the notarization
- Signature of everyone who signed the document
- The right thumbprint of anyone who signed the document
5. Fill Out the Notary Certificate
Some documents will already have a special section designated for the actual notarization. For example, most subordination agreements will include space for notarization within the document itself. However, it is entirely common for documents to leave this out of the actual document. If that is the case, the notary will attach a separate notary certificate to the document.
Whether within the document or attached, this space will be where the notary signs and stamps the document. A notaries stamp is unique to them. Notary stamps detail their name, state of commission, and commission expiration date. Most notaries official commission lasts for four years at a time. However, the expiration date stamped on your document does not affect the validity of your document. The expiration date only marks the expiration of that particular notaries current commission.
Where to Locate a Notary Near You
Congratulations! You now know what happens during a notarization. However, you may still be wondering where to find a notary public. Fortunately, you don’t have to go far to find one. With over four million notaries nationwide, you can easily find a notary near you. Read on to find a few places to start your notary search.
1. Credit Unions and Banks
Most notarizations deal with documents of a legal or financial nature. Therefore, it makes total sense to find notaries working in your local banks. Even better, if you are an account holding member at a bank, you may benefit from complimentary notary services.
2. Local Businesses
Many businesses find it beneficial to have a notary on staff. This not only expedites internal business but is a nice community bonus. Some places to look for a notary:
- Car Dealerships
- Home and Auto Insurance Agencies
- AAA Offices
- Colleges and Universities
- Real Estate Offices
- Public Libraries
Be sure to call ahead to confirm notary availability and pricing. Furthermore, keep in mind that notaries are servants of the public. Therefore, you do not have to be a customer or a client at any of the above institutions to access their notary.
3. Government Buildings
Many local government agencies will have a notary available on site. Local courthouses, town halls, or county clerk’s offices may have a notary for community use.
4. Mobile Notary
Better yet, live in the lap of luxury and have a notary come straight to you! For the ultimate in ease and efficiency, many metropolitan areas boast the services of mobile notaries. These notaries will come directly to you at your home or workplace. Keep in mind that you will have to pay an added fee to cover the notaries travel time and expense. However, convenience is worth the cost.
Subordination Agreement: In Conclusion
At the end of the day, loans can be a slippery slope for both the borrower and the lender. Ceratin legal documents protect everyone involved. Subordination agreements ensure that a primary lender will be paid in the event the borrower takes on more debt. As with most legal documents, subordination agreements need to be notarized in order to be official in the eyes of the law. Now, go forth and borrow and buy responsibly!