Junior liens: Overview, definition, and example
What are junior liens?
Junior liens are secondary claims on a property or asset that are subordinate to a primary lien. If the owner defaults on payments, the primary (senior) lienholder is paid first, and junior lienholders are only paid if there are remaining funds. Junior liens typically arise in mortgages, business loans, and secured transactions.
For example, if a homeowner takes out a second mortgage, that loan becomes a junior lien because the original mortgage (first lien) takes priority if the property is sold or foreclosed.
Why are junior liens important?
Junior liens are important because they affect lender risk, debt repayment priorities, and borrower financing options. Since junior lienholders are second in line for repayment, these loans often carry higher interest rates to compensate for the increased risk.
For businesses and individuals, understanding junior liens is crucial when refinancing debt, obtaining second mortgages, or securing multiple loans against the same asset. A junior lienholder may also negotiate subordination agreements to adjust lien priority in certain cases.
Understanding junior liens through an example
A business takes out a $500,000 loan secured by its office building. The lender files a first lien on the property. Later, the business secures a $200,000 line of credit using the same property as collateral. The second lender places a junior lien on the asset. If the business defaults, the first lender is paid first, and the junior lienholder receives payment only if there are remaining funds.
In another case, a homeowner has a primary mortgage and then obtains a home equity loan. The home equity loan becomes a junior lien, meaning that in a foreclosure, the primary mortgage lender is repaid before the home equity lender receives any funds.
Example of a junior liens clause
Here’s how a junior liens clause might appear in a contract:
“The Borrower agrees that any liens placed on the Collateral after the execution of this Agreement shall be considered junior liens and subordinate to the rights of the primary Lender. In the event of default, all payments and proceeds from the sale of the Collateral shall be applied first to the primary lienholder before any distribution to junior lienholders.”
Conclusion
Junior liens represent secondary claims on assets, ranking below primary liens in repayment priority. Understanding how junior liens function is essential for borrowers managing multiple loans and lenders assessing risk. Including a well-drafted junior liens clause in agreements ensures clarity on debt priority and repayment terms, reducing legal and financial disputes.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.