Subordinated financing: what subordination means

A subordinated loan is often associated with lower interest rates. Find out why this is the case and how you can counteract it in this article.

The most important facts about subordinated financing at a glance

The most important information on subordinated loans is summarized below:

  • A subordinated loan is a loan whose basic debt is recorded in the land register after the 1st mortgage. Rank is registered. This is also referred to as "subordinate".
  • The term "subordinated loan" is commonly used as a synonym.
  • In the event of a forced auction, the proceeds will first be paid to the creditor of the first-ranking land charge. If there is still something left, the creditor of the second-ranking basic debt is paid and so on.
  • Subordinated financing is often accompanied by poorer interest rate conditions.
  • Building societies or the kfw usually include a subordinated loan in the calculation. The interest rate conditions are then better than with an annuity loan.

What is subordinated financing?

Subordinated financing is the term used to describe a loan whose basic debt is not entered as a first-ranking lien in the land register, but is instead entered in the 2. Or 3. Rank, i.E. Subordinate. The term "subordinated loan" is often used as a synonym in practice. For subordinate financing, you usually get a worse interest rate than with first-lien financing.

Use our interest rate calculator to determine your individual rate. Taking into account the data entered, you will receive the current daily interest rate.

What is meant by "subordinate" in the case of a subordinated loan??

A real estate loan is secured by the bank having a land charge entered in the land register. If the borrower can no longer afford his monthly payment, the bank can schedule a foreclosure to use the proceeds to pay the outstanding installments. With the registration of the land charge, the bank receives a so-called "right in rem" to exploit the property.

If this scenario occurs, the first bank to receive its money is the one whose first-ranking mortgage is entered in the land register. If there is still money left over, the subordinated lenders also receive their outstanding claims.

What is the difference between senior financing and subordinated financing??

For its first construction financing, the bank is entered in the land register as first-ranking creditor. Our land register calculator will show you the costs involved. Let's assume you now want to take out another construction loan while the first one is still running. For example, because you still want to finance an extension. Then the bank granting you the second construction loan is entered in the land register as subordinate to your first bank. This is why we also speak of a subordinated loan or subordinated financing.

The second bank then also receives security for the money lent through the land register entry. If you subsequently become insolvent, this means that the first bank may put its right of realization into practice first, and then the second bank. Because it is impossible to say for sure whether there will be anything left for the second bank after the foreclosure, for example, subordinated financing involves a higher risk for them. For this reason, subordinated loans are generally more expensive than senior loans. The second bank offsets its risk through higher interest rates.

What interest rates can I expect with subordinated financing??

In most cases, subordinate financing is associated with higher construction interest rates. This means that the interest rates on a subordinated loan are significantly worse than the interest rates on a senior loan. The differences here are between 0.3 and 0.9 percentage points.

If you can offer the bank an equivalent security that is not pre-encumbered, it may waive an interest rate increase.

Some lending institutions are already prepared for the increased risk that comes with subordinated financing. A kfw subsidy or offers from building societies are not necessarily associated with worse interest rates.

What does subordinated financing mean in practice??

Here is an example of what subordinated financing means in practice.

Let us assume that there are 2 loans. One loan is registered with a first-ranking land charge in the land register, the other loan is registered with a second, a subordinate land charge:

The borrower is no longer able to meet his or her payment obligations. There is a forced auction. The proceeds from the foreclosure sale are 100.000 €. This results in the following breakdown:

  • The loan with the first-ranking land charge can be repaid in full with the proceeds.
  • The loan with the subordinated land charge can only be repaid with 50.000 € are repaid.

This means: the bank, whose land charge is subordinated in the land register, remains liable for costs in the amount of 30.000 € sit.

What role does the mortgage lending value play in a subordinated loan??

With the mortgage lending value, the bank determines the amount it would lend to the borrower. As a rule, the bank does not finance the entire purchase price of a property. The mortgage lending value is the amount a bank is likely to receive in the event of an auction. The bank usually expects to pay 70 to 90 % of the purchase price. The lending limit, i.E. The maximum amount that a bank is willing to pay, is derived from 60 % of the mortgage lending value. The table illustrates the figures:

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