What does "subordination" refer to in financing?

In financing, "subordination" refers specifically to the ranking of liens against a property. When a property has multiple liens, such as mortgages or judgments, subordination determines the order in which these liens will be paid off in the event of a foreclosure. The first lien to be recorded typically holds the highest priority and is paid first, followed by subsequent liens in the order they were recorded.

Understanding this hierarchy is crucial for lenders and borrowers alike because it affects the risk associated with lending. For example, if a borrower takes out a second mortgage or home equity line of credit, the lender of that second position loan is subordinate to the first mortgage lender, meaning they are only repaid after the first mortgage has been satisfied in a foreclosure scenario. This can influence the willingness of lenders to provide additional financing and the terms they may offer, as subordinate loans typically carry higher interest rates due to increased risk.