A mortgage provides security to the lender in Real Estate transaction. It is recorded at the county courthouse as a lien against the property. When the property is sold, the lender is the first to receive money from the proceeds of the transaction. What if there are more then one mortgage? Then the concept of “position” comes into play.
Before I discuss position, it would be best to review the chart above. It is a diagram that outlines the key documents that get created when a property is purchased. The buyer and seller are tied together by a Purchase and Sale agreement. This document specifies the agreements that were made between the buyer and seller.
The buyer and the property are tied together by the Warranty Deed. This document specifies that the buyer holds title tot he property once the sale is complete.
The buyer and lender are tied together by the promissory note. This document specifies the agreed to terms of the loan that the buyer is receiving from the lender. This would include interest rate, payment due dates, length of the loan etc.
The mortgage is the document that provides security to the lender. Since it is filed as a lien against the property, it enables the lender to foreclose on the property if the loan is not being paid to the conditions spelled out in the promissory note.
If there is more than one lender, then each lender will have a promissory note and mortgage. Each mortgage is filed as a lien against the property at the county courthouse.
If there is more than one lender, then there needs to be a mechanism to determine which lender has priority to the money generated from the proceeds of the sale of the property. This is important for there may not be enough money generated from the sale of the property to pay all the lenders the money they are owed. For example, if a buyer borrowed $500,000 dollars to purchase a house. The buyer had two loans and borrowed $400,000 dollars from lender “A” and $100,000 dollars from Lender “B”. If later, the property is sold for $450,000 dollars. The sale of the property will not cover the money needed to pay off the lenders. One of the lenders is going to lose $50,000 dollars.
Which lender gets paid 1st is determined by the position that they have agreed to loan the money in. In most cases, the lender who loaned the most money is in 1st position. This means they will get paid 1st. The lender who loans the next highest amount would be in 2ndposition. If there is a third loan, then this loan would be in 3rdposition.
The position has to be agreed to by the lenders. A lender may agree only to loan in 1stposition. If the other lenders agree, then a lender of a lower loan amount could be in 1stposition. In practice, this hardly ever happens. The reason is that the lower the position, the riskier the loan.
In the example above, the 1stposition lender who loaned $400,000 dollars would receive the full amount of the loan from the proceeds of the sale of the property. The lender of the $100,000 (2ndposition loan) dollars would only receive $50,000 dollars. They would still be owed the remaining $50,000 by the borrower.
The 2ndposition lender would then have to decide if they would try and recover the remaining $50,000 dollars from the borrower. This would involve hiring an attorney and using the legal system to try and recover the remaining money.
If both lenders want to loan in 1stposition only, then the borrower decides which lender he wants to borrow money from that would be in 1stposition. The borrower would then have to go and find another lender that would be willing to lend in 2ndposition. No lender can be forced to make a loan that does not meet the terms they are looking for.
Position is important when making a Real Estate Loan. A higher position loan is more secure and receives priority to the money generated from the sale of the property. Position does not guarantee that a lender will make a profit when lending money. It guarantees which lender has priority to the available money.
During the closing of the property, the lender needs to make it clear to the escrow agent which position they are lending the money in. The documents then have to be filed at the county courthouse with the correct position specified. This is generally documented in the order in which the mortgages are filed.
Finally, since a lower position loan is riskier than a higher position loan, it is logical that the lower position loan would be compensated for the higher risk by generating a higher return through a higher interest rate.