B2-1.2-04, Subordinate Financing (05/03/2023)

Fannie Mae purchases or securitizes first-lien loans where the secured property is subject to subordinate financing, except for co-op share loans that are subject to subordinate financing. (See  B5-7-01, High LTV Refinance Loan and Borrower EligibilityB5-7-01, High LTV Refinance Loan and Borrower Eligibility  for exceptions to this policy.) Subordinate liens must be

• evidenced by a promissory note;
• reflected in a recorded mortgage, deed of trust, or other security instrument; and
• clearly subordinate to Fannie Mae’s first mortgage.

Lenders must disclose the existence of subordinate financing and the subordinate financing repayment terms to Fannie Mae, the appraiser, and the mortgage insurer.

Note: Unless it qualifies as a Community Seconds loan, an agreement under which a borrower is obligated to pay a third-party (other than a co-owner of the subject property) a share in any appreciation in the value of the subject property is not permitted.

The lender must consider all subordinate liens secured by the subject property, regardless of the obligated party, when calculating CLTV and HCLTV ratios. This includes business loans, such as those provided by the Small Business Administration.

Except as described in Acceptable Subordinate Financing below or under Section B5-5.1, Community Seconds, no other type of recorded instrument documenting or securing the borrower's obligation to pay an amount in connection with funds advanced to the borrower in relation to the first mortgage is permitted, unless those funds have been advanced to the borrower by a co-owner of the subject property. Regardless of whether it qualifies as financing, eligible subordinated or unsecured PACE structures are permitted in accordance with  B5-3.4-01, Property Assessed Clean Energy LoansB5-3.4-01, Property Assessed Clean Energy Loans.

For more information on subordinate financing originated in connection with the Section 502 Leveraged (Blended) Loan Program, see B6-1-05, Eligible RD-Guaranteed MortgagesB6-1-05, Eligible RD-Guaranteed Mortgages.

The table below provides the requirements for acceptable subordinate financing, other than an eligible Community Seconds loan.

If the interest rate for financing provided by the property seller is more than 2% below current standard rates for second mortgages, the subordinate financing must be considered a sales concession and the subordinate financing amount must be deducted from the sales price.

The table below describes examples of unacceptable subordinate financing terms on financing that does not qualify as an eligible Community Seconds mortgage.

For additional information about applicable subordinate financing policies, see the following topics:

B5-5.1-02, Community Seconds Loan EligibilityB5-5.1-02, Community Seconds Loan Eligibility,

B4-2.3-04, Loan Eligibility for Co-op Share LoansB4-2.3-04, Loan Eligibility for Co-op Share Loans, and

B5-7-01, High LTV Refinance Loan and Borrower EligibilityB5-7-01, High LTV Refinance Loan and Borrower Eligibility.

Fannie Mae permits variable payments for subordinate financing that does not qualify as an eligible Community Seconds loan if the following provisions are met:

• With the exception of HELOCs, when the repayment terms provide for a variable interest rate, the monthly payment must remain constant for each 12-month period over the term of the subordinate mortgage. (For HELOCs, the monthly payment does not have to remain constant.)

• The monthly payments for all subordinate liens must cover at least the interest due so that negative amortization does not occur (with the exception of employer subordinate financing that has deferred payments).

If the subordinate financing is from the borrower’s employer, it does not have to require regular payments of either principal and interest or interest only. Employer subordinate financing may be structured in any of the following ways:

• fully amortizing level monthly payments,

• deferred payments for some period before changing to fully amortizing level payments,

• deferred payments over the entire term, or

• forgiveness of the debt over time.

The financing terms may provide for the employer to require full repayment of the debt if the borrower’s employment is terminated (either voluntarily or involuntarily) before the maturity date of the subordinate financing.

Refer to B3-4.3-08, Employer AssistanceB3-4.3-08, Employer Assistance, for additional information.

If subordinate financing is left in place in connection with a first mortgage refinance transaction, Fannie Mae requires execution and recordation of a resubordination agreement.

If state law permits subordinate financing to remain in the same subordinate lien position established with the prior first mortgage that is being refinanced, Fannie Mae does not require resubordination. The subordinate lien must satisfy any specified criteria of the applicable statutes.

Note: Title insurance against the fact that a former subordinate lien is not properly resubordinated to the refinance loan does not release lenders from compliance with these resubordination requirements, or from Fannie Mae’s requirement that the property is free and clear of all encumbrances and liens having priority over Fannie Mae’s loan.

The table below provides the underwriting considerations related to subordinate financing under refinance transactions.