Subordination vs. Subrogation

Subordination means to give up priority to an anticipated future mortgage or lien, whereas subrogation means to substitute a creditor who succeeds to the rights of another.

Subrodination — An agreement whereby a holder of a prior superior mortgage agrees to subordinate or give up his or her priority position to an existing or anticipated future lien. Subordination agreements are frequently used in development projects where the seller of the land to be developed takes back a purchase-money mortgage and agrees to subordinate the mortgage or become subject to a construction loan, thereby enabling the developer/purchaser to obtain a first mortgage loan to improve the property. The subordination agreement thus alters the normal rule of giving priority to the first recorded mortgage. As a result, the construction mortgage, even though recorded after the existing purchase-money mortgage, becomes the first mortgage.   Many interim lenders refuse to lend any money in the absence of a subordination clause in all prior loans or other agreements. Thus, most presale purchase contracts for proposed condominium units have a clause subordinating the apartment purchaser’s right to buy the apartment (equitable lien) to any future interim construction mortgage given by the developer. Thus on default, the lender could wipe out the purchase contract if it wanted to do so.

Some states have statutes requiring specific forms and certain disclosures of subordination agreements. It might be considered the unauthorized practice of law for the broker to draft a subordination clause.

Subrogation — The substitution of a third person in place of a creditor to whose rights the third person succeeds in relation to the debt. For instance, a title company that pays a loss within the scope of its policy is subrogated to any claim that the buyer has against the seller for a loss. Insurance policies typically contain subrogation clauses. Whenever a payment is made from a state real estate education, research, and recovery fund to satisfy a judgment, the fund is subrogated to the rights of the injured party.   If the Department of Veterans Affairs makes advances to the mortgagee due to the default of the veteran-mortgagor, the VA is subrogated to the rights of the mortgagee against the mortgagor to the extent of these advances.