SUBROGATION: WHY THE FIRST TO RECORD A LIEN ISN’T ALWAYS THE ONE WITH THE BEST LIEN POSITION.
In Illinois, the general rule is that lien priority is awarded to whoever records a lien against property first. In other words, a mortgage recorded in 2005 has priority over a mortgage recorded in 2008. This concept is often referred to as “first in time, first in right.” If the property encumbered by the mortgages is eventually sold, the holder of the mortgage recorded first gets paid first.
But there are exceptions to “first in time, first in right.” One such exception is called subrogation.
Subrogation is really just another word for “substitution.” The concept often applies during a transaction where you refinance an existing loan on your house in order to obtain a better interest rate.
For example, let’s say that you purchased property in 2015. In order to pay for the property, you take out a loan. In exchange for the loan, the bank gets a mortgage as collateral to ensure that you pay the loan back.
Assume that a few years later in 2018, you fall behind on your Illinois state taxes. As a result, the state of Illinois records a lien against you for the amount of taxes owed. The lien attaches to any real estate that you own located in Illinois.
In 2020, you decide that in order to pay the Illinois state taxes, you are going to refinance your original loan and mortgage from 2015. But if the bank loans you money and you give the bank a new mortgage, the bank’s new mortgage will be recorded after the Illinois state tax lien. It is technically inferior to the Illinois state tax lien and the state of Illinois would get paid first if your property is sold.
But also assume that in giving you the new 2020 loan, the bank used a portion of that loan to pay off your old 2015 loan. This is when subrogation comes into play.
The bank’s new 2020 mortgage can be subrogated, or “substituted,” into the lien position originally enjoyed by the bank’s 2015 mortgage. This would give the bank’s 2020 mortgage priority over the state of Illinois 2018 tax lien.
Subrogation is rooted in good public policy. If a bank pays off an old loan secured by an old mortgage, the bank’s new loan and mortgage should be substituted in the old mortgage’s lien position. This encourages banks to refinance loans to give customers better interest rates, without losing their place in line to collect any proceeds if property is eventually sold.