Subordination Requests for Existing Lines of Credit

With interest rates so low right now, there has been
a wave of refinances. There are tremendous savings
for borrowers to reduce their interest rates on their
home loans.

A large percentage of borrowers have both a first
loan and a second loan on their homes. Many times
the second loan is the popular Home Equity Line of
Credit (HELOC) which borrowers like to have
available to use in case of emergencies, or if an
opportunity presents itself.

When a borrower requests a refinance, and if there
is a second loan on the property, we need to make
sure that the borrower understands their options.

Assuming that the property value supports the
loan request the borrower may elect to:

A. Payoff the first loan and the second loan and
close the HELOC.

B. Payoff the first loan and the second loan and
retain the availability of the HELOC.

C. Payoff the first loan and retain the balance and
availability of the HELOC.

Each of these choices involve some different
considerations. Let's recap what needs to be done
to meet these different outcomes.

It is helpful to think of the loans on the property
as being rungs on a ladder. The existing first
loan is the top rung, the existing second loan is
the next in line.

When we refinance, the new loan that is being
created is designed to be the new first loan.

In scenario A, above, the new loan pays off
the existing first loan and existing second loan,
removing those rungs from the ladder and the
new loan becomes the top rung.

In scenario B, the new loan pays off the existing
first loan and pays the existing second loan to
a zero balance, but does not close out the HELOC.

In scenario C, the new loan pays off the existing
first loan and does not pay to zero or close out
the existing HELOC.

In scenarios B and C, the existing first loan is
gone, removing the top rung of the ladder.
However, whether the balance is zero or not,
the existing HELOC is now the top rung of the
ladder and the new loan is in the second position.

But wait, the new loan is supposed to be in first
position. What can be done?

This is where the process of subordination comes
into play. In this case, subordination refers to
the situation where the existing second lender
agrees to move their loan back down to a secondary
position to the new first loan that is being created.

As a practical matter, the new first lender will
have guidelines and requirements that not only
stipulate the percentage of value that the first loan
can be (loan-to-value ratio or LTV), but will also
have requirements for the percentage of value
that the combination of the new first loan and
existing HELOC can be (combined loan-to-value
ratio or CLTV).

Additionally, the existing HELOC lender will also
have CLTV guidelines and requirements. As a
general rule, they do not want to be in a largely
riskier position when approving the subordination
request.

Let's take a look at a couple of examples.

Property value $500,000.
Existing first loan $300,000. (LTV = 60%)
Existing second loan $100,000. (CLTV = 80%)
New loan request of $300,000 to replace the
existing first loan. (LTV = 60%)

In this case, the existing HELOC lender is in a
reasonably secure position, with their exposure
to risk at the 80% level. Under the new loan
request, they are being asked to consider keeping
their exposure to risk at the 80% level. There is
a good likelihood that they would approve the
subordination request without modifying the
amount of the HELOC.

Property value $500,000.
Existing first loan $300,000 (LTV = 60%)
Existing second loan $100,000 (CLTV = 80%)
New loan request of $400,000 to payoff first
loan and pay HELOC to zero. Wants to retain
availability of the HELOC going forward.

In this case the new LTV would be 80%. The
request to the existing lender to subordinate
their HELOC would put their exposure to risk
at 100% ($400,000 first loan and $100,000
available on the HELOC). It is highly unlikely
that the lender would approve this subordination
request and would probably insist that the
HELOC be closed out, since the lender will not
want to increase their risk exposure to that
level.

Subordination requests are useful tools to help
a borrower meet their financial planning goals.
But it takes proper research to make sure that
we can navigate through the guidelines of both
the new first lender and the existing HELOC
lender.

Also, borrowers need to be patient as well. We
are finding that the HELOC lenders are taking
as much as 30-45 days to process these requests.
This can affect the ability to meet interest rate
lock expiration dates, or become more costly to
the borrower if rate lock extension fees are
necessary.

Make sure that your goals are well-defined as
you beginn this process to that a strategic plan
is developed to avoid any pitfalls through the
process.