Subordination Policy of Second Mortgage Lenders
May 24, 1999, Revised November 30, 2006, September 3, 2009
Most economists view mandatory disclosure as a reasonable way of making a market work better if the market is one in which one party to the transaction knows much less than the other. This is the rationale for the extensive disclosure requirements imposed on mortgage lenders. Lenders are obliged to incur heavy costs to provide borrowers with information the Federal Government believes borrowers need to protect themselves.
Unfortunately, the implementation of Federal mandatory disclosure rules has been so poor that it is not even clear that the disclosures do borrowers more good than harm. Borrowers are overwhelmed with information they often don't understand, and critically important information that they would understand is nowhere to be found.
As a particularly glaring example, there is no requirement to disclose the total upfront credit charge -- the total amount the borrower must pay the lender and mortgage broker for the loan. Aside from the interest rate, this is the single most important piece of information a borrower can have, yet it is not shown in either the Truth in Lending Statement (TIL) required by the Federal Reserve nor the Good Faith Estimate of Settlement (GFE) required by HUD.
Recently, my mailbox has alerted me to another glaring shortcoming in disclosure requirements. This one applies to second mortgages, a rapidly growing segment of the market.
"I obtained an FHA adjustable rate loan 1 1/2 years ago, and later took out a second mortgage. When FHA came out with a program providing for a streamlined refinance into a fixed-rated loan, I applied for one and was approved. To my surprise, however, I found that the second mortgage lender must agree to be subordinated to a new first mortgage, and my second mortgage lender categorically refuses. I have written the president of the bank and gotten no response…It never occurred to me to ask about this when I took out the second mortgage, and the lender's policy of refusing to subordinate was nowhere disclosed…"
What shook me up about this letter is that it could have happened to me. I was aware that the second mortgage lender had to agree to be subordinated to a new first mortgage, but I was not aware that there were lenders who categorically refuse to do it.
Such stubbornness makes no business sense. So long as the borrower is not increasing the balance of the first mortgage, which was the case for the letter-writer, the position of the second mortgage lender is not affected by the replacement of one first mortgage with another. Indeed, since the interest rate will be lower, which reduces the payment burden on the borrower, the position of the second mortgage lender is if anything strengthened. OK, it takes a little clerical time to fill out the necessary forms, so charge the borrower a reasonable amount for your trouble. But refusing to be bothered? That's treating your customers with contempt!
Second mortgage lenders should be required to disclose their subordination policy in their Truth in Lending statement. A suggested sample disclosure is contained below. If they want to limit subordination to cases where the balance of the first mortgage is not increased, fine. If they want to be pig-headed and refuse to allow it under any circumstances, that's fine too, so long as consumers are forewarned about this when they take out their loan.
But consumers should not hold their breath waiting for the regulations to be changed. Mortgage disclosure is a politically super-charged area that moves at a glacial pace when it moves at all. You must protect yourself, and the way to do it is to ask about subordination policy at the first contact with a lender.
If the lender doesn't allow subordination, march out the door. There's another second mortgage lender down the street. If they say they do allow it, ask about conditions if any, if there is a fee and how long it will take. If the answers are satisfactory, get it in writing and make sure it is incorporated in the loan documents so that if the loan is sold the new lender will be bound by it. Note: You cannot expect a lender to commit to subordinate your loan, that is unreasonable, but they should be willing to commit to a policy that indicates when they will and when they won't subordinate.
Most economists view mandatory disclosure as a reasonable way of making a market work better if the market is one in which one party to the transaction knows much less than the other. This is the rationale for the extensive disclosure requirements imposed on mortgage lenders. Lenders are obliged to incur heavy costs to provide borrowers with information the Federal Government believes borrowers need to protect themselves.
Unfortunately, the implementation of Federal mandatory disclosure rules has been so poor that it is not even clear that the disclosures do borrowers more good than harm. Borrowers are overwhelmed with information they often don't understand, and critically important information that they would understand is nowhere to be found.
As a particularly glaring example, there is no requirement to disclose the total upfront credit charge -- the total amount the borrower must pay the lender and mortgage broker for the loan. Aside from the interest rate, this is the single most important piece of information a borrower can have, yet it is not shown in either the Truth in Lending Statement (TIL) required by the Federal Reserve nor the Good Faith Estimate of Settlement (GFE) required by HUD.
Recently, my mailbox has alerted me to another glaring shortcoming in disclosure requirements. This one applies to second mortgages, a rapidly growing segment of the market.
"I obtained an FHA adjustable rate loan 1 1/2 years ago, and later took out a second mortgage. When FHA came out with a program providing for a streamlined refinance into a fixed-rated loan, I applied for one and was approved. To my surprise, however, I found that the second mortgage lender must agree to be subordinated to a new first mortgage, and my second mortgage lender categorically refuses. I have written the president of the bank and gotten no response…It never occurred to me to ask about this when I took out the second mortgage, and the lender's policy of refusing to subordinate was nowhere disclosed…"
What shook me up about this letter is that it could have happened to me. I was aware that the second mortgage lender had to agree to be subordinated to a new first mortgage, but I was not aware that there were lenders who categorically refuse to do it.
Such stubbornness makes no business sense. So long as the borrower is not increasing the balance of the first mortgage, which was the case for the letter-writer, the position of the second mortgage lender is not affected by the replacement of one first mortgage with another. Indeed, since the interest rate will be lower, which reduces the payment burden on the borrower, the position of the second mortgage lender is if anything strengthened. OK, it takes a little clerical time to fill out the necessary forms, so charge the borrower a reasonable amount for your trouble. But refusing to be bothered? That's treating your customers with contempt!
Second mortgage lenders should be required to disclose their subordination policy in their Truth in Lending statement. A suggested sample disclosure is contained below. If they want to limit subordination to cases where the balance of the first mortgage is not increased, fine. If they want to be pig-headed and refuse to allow it under any circumstances, that's fine too, so long as consumers are forewarned about this when they take out their loan.
But consumers should not hold their breath waiting for the regulations to be changed. Mortgage disclosure is a politically super-charged area that moves at a glacial pace when it moves at all. You must protect yourself, and the way to do it is to ask about subordination policy at the first contact with a lender.
If the lender doesn't allow subordination, march out the door. There's another second mortgage lender down the street. If they say they do allow it, ask about conditions if any, if there is a fee and how long it will take. If the answers are satisfactory, get it in writing and make sure it is incorporated in the loan documents so that if the loan is sold the new lender will be bound by it. Note: You cannot expect a lender to commit to subordinate your loan, that is unreasonable, but they should be willing to commit to a policy that indicates when they will and when they won't subordinate.
Suggested Disclosure on Subordination
Is Subordination Allowed?
Yes No Conditional Period Fee
New First Mortgage
No Change in Balance
Balance Includes Refi Costs
Cash-out
Note: If conditional, explain the condition