Subordination Agreement

Definition of 'Subordination Agreement'

A legal agreement which establishes one debt as ranking behind another debt in the priority for collecting repayment from a debtor. The priority of debts is extremely important if the debtor defaults on payments or declares bankruptcy.

Debts which have a higher priority have a legal right to be repaid in full before lower priority debts receive any repayments. Often, the debtor does not have enough funds to pay all debts, and lower priority debts may receive little or no repayment. Therefore, subordinated debts are much more risky, and lenders will require a higher interest rate as compensation.

Investopedia explains 'Subordination Agreement'

Subordination agreements may be used in a variety of circumstances, including complex corporate debt structures. For an individual, the most frequent example of a subordination agreement is when an individual attempts to refinance the first mortgage on a property which has a second mortgage. The second mortgage has a lower priority than the first mortgage, but these priorities may be upset by refinancing the loan. Therefore, a subordination agreement must be enacted by the second mortgage holder to ensure that the new refinanced mortgage has the first priority for repayment.